The Opportunity To Build An Energy Portfolio Is Right Now

One of the blessings that comes with the territory of investing in individual companies rather than a widespread basket of stocks like the S&P 500 is that you get to allocate your money to specific companies that are either growing faster than the S&P 500 or selling at a substantial discount to the typical stock in the S&P 500. It’s a style of investing that lets you personally find intelligent places to put your money even when “the average stock” in corporate America does not offer you an attractive entry price.

In the ‘50s and ‘60s, you had IBM outperforming the S&P 500. In the ‘60s and ‘70s, you had the tobacco giants and conglomerate-type businesses of General Electric, United Technologies, ITT, and Procter & Gamble roaring to life. Someone who bought Coca-Cola in the early 1980s has been compounding at 15.5% ever since. Buying Disney and Nike in the 1990s was incredibly intelligent. There is always something intelligent to do.

For someone looking to figure what the intelligent thing to do in November 2014 might be, you can look no further than the oil sector. Did you see what happened to commodity stocks on November 28th? There is one of those rare times where you can throw darts and buy just about any large-cap in the commodities field, and you’ll be setting yourself up for great long-term returns.

Want an oil company with a high earnings per share growth rate over time? Look at something like Phillips 66. Want a big honkin’ dividend yield? Look at BP and Royal Dutch Shell. Want something that will be raising its dividend for decades, something quite unusual in the extra-cyclical commodities industry? Look to Chevron and Exxon. Want to capture the declines in other commodities beyond just oil? Look to BHP Billiton. This is a very attractive time for long-term investors that don’t mind working their way through the inevitable swings in prices—I mean, Chevron is on the verge of yielding 4%, for heaven’s sake. Where else can you get a 4% yield that will grow in the 8-11% for the lifetime of your holding?

This is one of those amazing opportunities, and I would credit Dr. Jeremy Siegel at Wharton for having the state of mind/framework for recognizing this as an opportunity rather than looking at the price declines as something to lament. Page 7-9 of his book The Future for Investors is one of the most persuasive bits of investment wisdom I’ve ever encountered. Siegel mentions these facts by way of a comparison between Exxon and IBM: From 1950 through 2003, Exxon grew its revenues by 8% annually, grew its dividends by 7% annually, and grew its earnings by 7.5% annually. IBM, meanwhile, delivered much better operational metrics over that period of time: it grew its revenues by 12% annually over that fifty-three year stretch, grew its dividends by 9% annually over that stretch, and grew its annual earnings per share by 11%.

By each of those measures, IBM would appear to be the far superior investment. Yet Exxon delivered 14% annual returns to investors over that time frame while IBM delivered 13.8% annual returns. Why is it that Exxon, which grew its profits and dividends slower than IBM, was able to outperform it over the course of 53 years? The valuation. Oil stocks like Exxon, Chevron, BP, Shell, and Conoco are prone to extended periods of cheapness, and this is where the oil stocks get their ability to outperform.

Professor Siegel puts it well: “A very important reason that valuation matters so much is the reinvestment of dividends. Dividends are a critical factor for driving investor returns. Because Standard Oil’s price was low and its dividend yield much higher, those who bought its stock and reinvested the oil company’s dividends accumulated almost fifteen times the number of shares they started with, while investors in IBM who reinvested their dividends accumulated only three times their original shares. Investors in Exxon had very modest expectations for earnings growth and this kept the price of its shares low, allowing investors to accumulate more shares through the reinvestment of dividends. These extra shares proved to be the margin of victory.”

It is fun getting to see a textbook case scenario unfold in real time, right before our very eyes all over again. Buffett often speaks of how when a stock is cheap, you just know it, and you don’t have to break out the calculator to study its pension assumptions and so on because the clarity of the value is there. I get that vibe from Chevron right now. This $108 price is getting 15-20% undervalued, which is extra-nice given its extraordinary safety (in terms of generating profits over the long term) and excellent growth profile given its planned volume growth in 2016 and 2017. It is paying out $4.28 per share in dividends which has been increasing annually for three decades and still only consumes about a third of the company’s profits in this depressed environment. Exxon tells a similar story, as it now yields over 3%. A lot of people are frustrated that they can’t buy things like Hershey, Nike, and Disney today because they are so pricey compared to current profits. The decline in the prices of oil stocks is welcome news for those with cash to invest and looking for something to do today.

Originally posted 2014-11-28 20:42:04.

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15 thoughts on “The Opportunity To Build An Energy Portfolio Is Right Now

  1. Forthelonghaul says:

    perfect reminder tim that this isn’t a time to panic, it is a time to celebrate! i saw a tweet today from ian bemmer, that said “coal, oil, and gas 1980’s 82% of global energy, 2014 82% of global energy (iea)”. i can’t believe how much of the commentary from the pundits is crying “end of fossil fuels”. this is temporary if your horizon is years versus days/weeks/months.

  2. KeithX says:

    Nice article, Tim.  I’ve been buying BP, XOM, CVX, and BBL lately and will add more shares if the prices keep falling.  If you listen to the pundits, it seems that they expect that we will quit using fossil fuels within 20 years and that oil will be extremely cheap.  I am skeptical about how quickly we can convert to solar, wind, etc.  I also wonder about how the good old electrical grid will handle all of the electric vehicles that we will supposedly be driving, not to mention the replacement cycle for all of the batteries.  Maybe I should be buying GNRC and TSLA?

  3. Joe_G from Seeking Alpha says:

    KeithX Wind and solar are already competitive with conventional fuels:

    However, I agree with Tim’s position that this is the time to buy the oil companies.  Coal will soon be obsolete but we’re currently building the infrastructure that ensures natural gas will be with us for decades.  Oil will be a transportation fuel for years to come with increased use in Asia offsetting efficiency gains in the US and Europe.

  4. KeithX says:

    Joe_G from Seeking Alpha 
    You misunderstood my point, which is that it will take a long time to change the infrastructure to eliminate fossil fuels, not that solar and wind aren’t cost competitive.  A quote from the article that you cited (thank you):
    “Experts and executives caution that the low prices do not mean wind and
    solar farms can replace conventional power plants anytime soon.”
    Wind and solar aren’t available 24/7, so Khalil Shalabi, vice president for energy market operations and resource planning at Austin Energy, said that they see “value in combined-cycle gas plants”.  Anyway, my point was one of time of conversion, not price competitiveness.
    You can make an argument that fossil fuel prices will fall long term as other technologies replace them, either partially or in total, and I will be in full agreement.  But that will truly be long term, and in the meantime, I will enjoy the dividends in my retirement.

    Thanks for the thought starter!

  5. Jonnydee83 says:

    Wind and solar are not competitive with fossil fuels. They provide between 4-6% of our energy in the US and that is after they are heavily subsidized by the government (taxpayers). Germany did a massive push for “renewable energy” and it has been an economic and practical failure.
    If you think that wind and solar are so promising please be sure and sell me your xom, cvx and cop. I’ll gladly wait for the day when the invisible hand trumps political agenda.

  6. Joe_G from Seeking Alpha says:

    Jonnydee83 Oil and gas have the advantage of being entrenched in our economy and will remain at the center of US energy needs for decades to come but this is purely a product of inertia and incumbency advantage.  We already have houses, cars and power plants that run on fossil fuels so it’s not practical to scrap that infrastructure even if renewable sources are more efficient and cleaner.  

    The “invisible hand” is a myth, at least with regards to energy policy.  Our choice of energy is based on whatever policy the government blesses at the moment.  The US government has chosen to subsidize oil and gas for the past 60 years so that’s why our economy relies on fossil fuel.  Germany favors solar and wind and that’s why they get 30% of their energy from renewables.  Japan and France decided nuclear was their favored power source and they went in that direction.

  7. Jonnydee83 says:

    “For example, on wind energy, we get a tax credit if we build a lot of wind farms. That’s the only reason to build them. They don’t make sense without the tax credit.”
    -Warren Buffett

  8. Joe_G from Seeking Alpha says:

    Jonnydee83 Federal tax credits for renewable electricity in 2011 was $5.2 billion.  Federal tax credits for production of non-conventional (i.e. shale and deep water) fuels in 2011 was $14.1 billion.  

    Tell me again which is more competitive?

  9. Jonnydee83 says:

    Joe_G from Seeking Alpha Jonnydee83

    So we give $5.2 billion in tax credits to the industry that only provides us 4-6% of our energy?

    Warren Buffett invests in XOM to make a profit.  He invests in wind farms to reduce the tax bill on his XOM profit.  So to answer your question: Fossil Fuels are more competitive.

  10. Joe_G from Seeking Alpha says:

    Jonnydee83 Joe_G from Seeking Alpha It’s 4-6% today but it’s an emerging field, just like the oil was 100 years ago.  All nascent technologies get initial subsidies to get them off the ground.  The problem is when older, mature industries like oil and gas still get subsidies long after they need them, when that happens it just means they hired good lobbyists.

  11. Jonnydee83 says:

    Joe_G from Seeking Alpha Jonnydee83

    I don’t think we’re going to agree so I’m going to let this go.  But just to recap my view:  

    Wind/solar are not competitive with conventional.  The only reason people invest in wind/solar is for the tax breaks and subsidies, which come out of the pockets of hard working Americans.  On the other hand conventional energy has fueled our economy for the last 100 years, created millions of jobs, and paid billions in tax revenues to fund our way of life.  The push for wind/solar is political in nature, not economic or financial.  When politicians start trying to pick winners and losers it leads to corruption and also, possibly more important, it slows down the innovative, dynamic power of the free market.  If you are truly a proponent of wind/solar you should try and keep the government as far away as possible.

    Good luck with your investing.

  12. Joe_G from Seeking Alpha says:

    Jonnydee83 Joe_G from Seeking Alpha If you’re going to assess the competitiveness of renewables versus conventional fuel then you need to consider the subsidies that both sides enjoy and not just harp on tax credits for renewables while ignoring even bigger subsidies for oil and gas.

    I agree that politicians should not be in the business of picking winners.  But considering that US foreign and energy policy for the past 70 years has revolved around securing access to oil I’d say the biggest winner we picked was oil.  

    I’m actually buying BP, XOM and KMI lately because that’s where the bargains are and those companies are very good at deploying their lobbying efforts at maintaining the status quo.  It’s their relationship to government that will keep them profitable, not their supposed inherent competitiveness.

  13. Jonnydee83 says:

    Why not buy some Solar City? According to you, renewables are competitive with conventionals plus they are receiving massive subsidies. Sounds like a win win if you are convinced of their merit

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