Investors should take heart in energy stocks despite falling oil prices

  • Investors should stick with energy stocks despite the recent drop in oil prices, according to DataTrek.
  • The research firm offered three reasons to buy energy stocks, including bullish earnings estimates and cheap valuations.
  • “Apple and Microsoft, with a 6.5% and 5.4% weight in the S&P 500, are both bigger” than the entire energy sector with 5.2%.

A recent drop in oil prices has prompted some hedge funds to short energy stocks, but DataTrek Research co-founder Nicholas Colas doesn’t think it’s a good idea for a number of reasons.

Instead, Colas believes investors should buy energy stocks despite the 11% drop in oil prices over the past month. Over the same period, energy stocks rose around 1%, offering a rare divergence for a sector that tends to move along with the price of crude.

“Also, XLE [energy sector ETF] it’s up 63% this year, by far the biggest gainer in any sector,” Colas said in a note on Wednesday, alluding to the common thinking that energy stocks may need to take a breather and consolidate their recent gains.

But attractive valuations, a rise in earnings estimates and a big dividend are three good reasons why investors should stick with the energy sector.

attractive valuations

Even after its surge this year, the energy sector remains the cheapest group in the S&P 500, trading at just 10 times 12-month future earnings, Colas said. The S&P 500 as a whole is currently trading at a multiple of 17.2x. That’s still a huge discount for energy stocks.

Put another way, Apple and Microsoft, with a weighting of 6.5% and 5.4% in the S&P 500, are both larger in terms of market capitalization than the entire energy sector at 5.2%. Colas said.

And even with such attractive valuations, earnings continue to grow at a brisk pace for energy companies as they benefit from higher oil prices.

Earnings estimates are rising

“The problem with shorting energy stocks here is that Wall Street analyst estimates for 2023 keep going up,” Colas said.

An analysis of the eight largest energy companies in the sector saw an average upward revision of 2023 earnings estimates of 2% over the past month, while the average 2023 price-earnings ratio for the same companies was just 7.3. x.

“In our view, that’s a tough setup for a short call. Generally speaking, you want to short/underweight expensive names when analyst estimates are coming down. Energy doesn’t fit any of those criteria,” he said. queues.

a big dividend

Finally, the energy sector offers an attractive dividend yield of 4%, more than double the current S&P 500 dividend yield of 1.6%. That is especially attractive given the broader macro backdrop of high inflation and a possible slowdown in economic growth.

“Lastly, energy continues to be a cheap hedge portfolio against a geopolitical event that causes an oil shock,” Colas concluded.

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