This will be the second in a series of articles designed to find value in today’s stock market environment. However, it will be the first of 10 articles covering the 10 major general sectors. In my first article (found here), I laid the foundation that represents the two primary underlying ideas supporting the need to publish such a treatise. First and foremost, that it is not a stock market; rather it is a market of stocks. Second, that regardless of the level of the general market, there will always be overvalued, undervalued and fairly valued individual stocks to be found.
Additionally, my focus in this and all subsequent articles will be on identifying fairly valued dividend growth stocks within each of the 10 general sectors that can be utilized to fund and support retirement portfolios. Therefore, when I am finished, the individual investor interested in designing their own retirement portfolio should find an ample number of selections to properly diversify a dividend growth portfolio with.
With the above second notion in mind, this article will look for undervalued and fairly valued individual companies within the general sector 10 – Energy. Within this general sector, there are several subsectors which I list as follows:
My Selection Methodology
Before I go any further, an important disclosure is in order. I will produce a list of companies in this article (and all subsequent articles), that are names that I have hand-selected from a much larger universe. My selections were made by reviewing the individual earnings and price correlated F.A.S.T. Graphs™ on all appropriate companies that I identified within the sector. Some might say my method of identifying them was not very scientific, but I would counter that it was very thorough and comprehensive. On the other hand, I will admit to it being somewhat arbitrary and based on my own judgments.
Here is the basic method that I utilized. In order to find undervalued or fairly valued companies within the Energy Sector, I utilized the assistance of the F.A.S.T. Graphs™ screening tool in the following manner. First, I asked the screener to only look for companies within the sector 10-Energy. Then I asked to search for any company within the sector that had a current dividend yield of 2% or better. The only reason I chose a dividend yield of 2% or better is because it is above the current dividend yield of the S&P 500. Finally, I included ADRs and all companies listed on the Canadian stock exchanges.
This produced a gross list of 219 individual companies. Then I created a personal portfolio comprised of these 219 individual companies and sorted them in alphabetical order. Next, I reviewed the individual graphs of each company and either rejected it or added it to my final list of potential candidates based on whether or not I felt it had an adequate history and a reasonable level of consistency within that history. But most importantly, I looked for companies that I felt were reasonably valued, or close to it today, based on current earnings and expected future earnings growth. Then I broke my refined list into two categories:
1. Conservative Growth and Income – 14 companies made this list.
2. Aggressive Growth and Income – 40 companies made this list
Before I present each of these lists, and my featured selection from each, it’s important that the reader understands that these are prescreened lists of potential candidates prior to the necessary more comprehensive research effort. In other words, I am not recommending any of these stocks for current investment. Instead, I am recommending them as companies with good historical records that appear reasonably valued, and therefore, worthy of investing the time and effort to take a closer look at.
The Energy Sector: General Characteristics and Considerations
As I reviewed all the individual selections from my screened list of the Energy Sector, several attributes became readily apparent to me. First of all, a majority of companies in the Energy Sector seem to be very sensitive to recessions. More plainly stated, earnings tend to fall when recessions hit, and stock prices tend to follow. On the other hand, there is a tendency to see earnings grow rather dramatically after recessions end. This creates a certain degree of cyclicality, but not as much as a true deep cyclical.
Furthermore, I feel it goes without saying that the Energy Sector is actually quite diverse. What I’m alluding to here is that many energy companies have their prospects tied directly to the underlying prices of the commodities that they operate in. Of course, I am referring to oil, gas and coal as the primary commodities. On the other hand, there are companies in the Energy Sector whose prospects are not directly tied to underlying commodities prices. These would include pure transportation and storage companies. What this means is that a portfolio can actually hold more than one energy company and still be arguably diversified, rather than overweight energy.
Additional diversity characteristics of companies in the Energy Sector relate to the various business configurations and capital structures of many publicly-traded energy concerns. Of course, we have the traditional C Corp, which includes well-known majors such as Chevron, Exxon and BP, etc. These typically corporate structured energy companies operate and look like most every other publicly-traded company. However, the Energy Sector also is privileged, thanks to the Tax Reform Act of 1986 and the Revenue Act of 1987. These reforms allowed companies dealing with natural resources liquidity, tax benefits and unique structures, the most common of which is the MLP (Master Limited Partnership). Although there are tax considerations with including MLPs into qualified retirement accounts, they are not precluded. Royalty Trusts are an additional corporate structure that can be found within the Energy Sector.
Regarding capital structures, there are other important characteristics that require special attention and consideration. Traditional C Corps, display a tendency to reward shareholders consistent with other similarly-structured companies in other industries. In addition to raising their dividends regularly, the traditional publicly-traded energy company will often buy back, and therefore, reduce share count, as a method of increasing earnings. In contrast, MLPs display a tendency to be continuously issuing new shares to fund additional infrastructure, thereby raising share count. Royalty Trusts typically have a fixed number of trust units. Also, earnings tend to be of high importance to C Corps, while FFO (Funds From Operations), a close cousin the operating cash flow, are more relevant to MLPs.
As a result of the above, I have included mostly traditional C Corps in my conservative growth and income selections, and MLPs and Royalty Trusts make up most of the aggressive growth and income selections. These distinctions are predicated on risk considerations, as well as growth considerations. Royalty Trusts and MLPs tend to have high yields, and moderate prospects for growth. However, since there are exceptions to every rule, there are many MLPs that offer above-normal dividend yields and above-average capital appreciation and dividend growth.
Perspectives on Valuation
My research into the Energy Sector also revealed that ascertaining the fair market value of most energy companies is different than calculating the intrinsic values on most traditional companies. Over the past decade at least, it is readily apparent that Mr. Market has tended to apply a discounted fair market value to energy concerns instead of traditional intrinsic value assessments. To put this more plainly, for the past 10 years or so, the market has valued energy companies lower than it values companies in other sectors with the same or similar fundamentals.
One could hypothesize many reasons why this reduced valuation might be the case; however, to my way of thinking, it’s more important to know that this is a reality, than it is to know why it is. But perhaps it has to do with all the uncertainty associated with energy supplies, which include the risk of discovery, drilling, politics, environmental issues, etc. But regardless of why, it’s critical that the investor recognizes that energy companies are valued lower than other equivalent companies in different industries, thereby avoiding the mistake of overpaying when valuations on energy companies exceed historical norms, even when they are consistent with valuations on traditional companies in other sectors.
Conservative Growth and Dividend Income
As I previously mentioned, the majority of the companies I placed in the conservative growth and dividend income list are comprised of traditional C Corporations. Many of the most widely-recognized major oil companies made this list. If you don’t see one of your favorites on the list, it more than likely means that I currently consider it overvalued, and therefore, excluded. The following lists the companies that all appear reasonably priced based on historical norms, and I would consider all of these companies to be high-quality stocks. However, this does not