It’s no secret energy stocks have been on a tear. The sector is by far the stock market’s best performer, crushing the S&P 500 by a whopping 75% YTD.
Many worry the gains can’t last. Today, I’ll show you why energy still has room to run.
The sector remains widely under-owned and still comprises only 4.8% of the S&P 500 Index, down from a peak of 30% in 1980. I’ll use MAPsignals data to show you how to play it with best of breed, high yielding energy stocks and ETFs that are seeing heavy institutional buying… and generating big returns in this tough market.
The fate of energy stocks is obviously tied to oil and natural gas prices, both of which have soared since Russia invaded Ukraine in February. But the bull case doesn’t end there.
Energy Still Has Room to Run
The US overtook Saudi Arabia to become the world’s biggest oil and gas producer ten years ago. US shale producers have learned from past boom and bust cycles not to overproduce when prices are high. Instead, they’re returning record cash to shareholders though massive stock buybacks and dividends.
This newfound discipline is keeping supply tight and prices high. OPEC doesn’t have enough spare capacity to offset the 3 million barrels of lost Russian supply. Even slowing growth in the US, Europe and China hasn’t been enough to dent oil’s rally.
Here’s the bottom line – a big and sustained drop in oil and gas prices is unlikely until Russian supply is fully back online. That doesn’t seem likely any time soon.
In March, I published stocks follow earnings. I showed you how stocks and corporate profits track each other closely, posting a 94% long-term correlation. Energy’s recent leadership is a case in point. As energy stocks have soared so have the sector’s earnings (chart).
But get this. Energy’s profit growth is outpacing the sector’s price gains as energy earnings surge. They’re forecasted to rise a market leading 110% this year vs. only 9% for the S&P 500.
So, despite energy’s huge rally, valuations are still the lowest of any sector at only 10.8X consensus 12-month forward earnings forecasts. Energy still has room to run!
With earnings on the upswing let’s drill down on a few Big Money favorites in the energy space.
Check out Devon Energy, DVN. It’s a leading domestic oil and gas producer with a map score of 77 and a healthy 6.6% dividend yield that still trades at only 9X 2022 EPS. This stock is priced for much lower oil and gas prices. If prices remain firm, DVN has major upside.
Ditto for EOG Resources, EOG. It has a map score of 79, trades at only 8.6X 2022 EPS and is seeing heavy big money buying. It also sports a 2.1% dividend yield that’s been growing 28% a year for 5 years running.
Now, let’s focus on a basket of high-quality energy names. Check out the biggest energy ETF, XLE. It has a map score of 76 and gets you broad exposure to all the blue chips in the S&P 500 energy sector. It’s also the most liquid ETF in the category, sports a healthy 2.9% dividend yield and a rock-bottom 0.1% expense ratio.
Bringing It All Together
Energy stocks’ meteoric rise has scared most investors away. They’re cheap because few believe current earnings momentum is sustainable. If oil and gas prices stay high, there’s still big upside in energy stocks.
The reality is the transition to green energy will take decades. In the meantime, the investments in oil and gas exploration, production and transportation needed to keep pace with growing global demand simply aren’t being made.
Oil prices will likely remain higher for longer and so will energy sector profits, buybacks, and dividends. That will continue to fuel an upward re-rating in the sector’s rock-bottom valuation. Use any weakness to initiate and gradually build positions in funds like XLE giving you broad exposure to the group. You’ll be glad you did.
Alright one last time, energy still has room to run!
Alec Young is an investment strategist, working on Wall Street since 2005. He currently serves as CIO at Tactical Alpha LLC.
Prior to TA, Alec spent 15 years in senior investment strategist roles at major financial firms. Most recently, he served as FTSE Russell’s Managing Director of Global Markets Research. Prior to that, he was VP & Investment Strategist at Oppenheimer Funds and served as Global Equity Strategist at S&P Global.
See his full bio here.