US energy companies clearly outperform S&P 500 – Here’s why it could continue to rise

• The energy sector is by far the best performer in the S&P 500 this year

• US oil companies are still cheaply valued
• There are no long-term growth prospects

Those who are declared dead live longer: In April 2020, in the middle of the corona shock, the prices of futures on WTI crude oil temporarily fell below 0 US dollars per barrel (about 159 liters). At that time, hardly any investors were keen on the papers of oil companies, which rushed down as a result. Since then, a phenomenal race to catch up has followed: most oil companies have not only doubled their value, but even multiplied it. In his MarketWatch column “Deep Dive,” Philip van Doorn takes a closer look at past performance and fundamentals in the energy sector.

Energy stocks significantly stronger than the overall market in the current year

Equities in the energy sector are considered good protection against inflation: the demand for energy hardly decreases as a result of currency depreciation, energy companies can pass the higher prices directly on to customers and shareholders enjoy high dividend yields even in times of inflation. The energy stocks experienced a further boost from the rapid increase in the price of crude oil to over 120 US dollars per barrel at times as a result of the western sanctions against the large oil exporting country Russia. According to FactSet’s John Butters, analysts expect US energy companies to grow their revenue by an average of 65 percent in 2022 thanks to high oil and gas prices. The good situation in the energy sector is directly reflected in the performance of the shares. Large oil companies from the USA such as Buffett’s favorite Occidental Petroleum, but also Chevron, ExxonMobil and Marathon Oil recently experienced an impressive price rally. Overall, the “Energy Sector” in the S&P 500 is up 25.88 percent in the current year (as of March 28, 2022), while the broad American leading index lost 2.82 percent in value. But can the energy sector maintain its outperformance as the year progresses?

Opportunity: price/earnings ratio low despite rally

What speaks for a further outperformance of the 21 companies in the energy sector is the continued low valuation of the companies. More specifically, the energy sector’s price-to-earnings (P/E) ratio of about 11 at the end of March, according to data from FactSet, remains well below the average for the top 500 companies in the US, which are trading at about 20 times their average in the stock market Profits are valued, according to van Doorn. The ratings are particularly high in the “Consumer Discretionary” sector, which also includes Amazon and Tesla, and in the “Information Technology” sector.

While the valuations of energy companies in the S&P 500 are 141 percent higher than the five-year average, the sector’s valuations are still only 60 percent of the entire index, notes van Doorn. So, compared to the other ten sectors of the S&P 500, energy remains the cheapest.

Problem: Limited future growth in the energy industry

However, what could slow down the triumph of the energy industry on the US capital market in the long term are the comparatively mediocre prospects for the future. More specifically, most oil and gas companies are no longer growing. According to FactSet data, energy company sales are expected to fall by 1.6 percent and profit by 4 percent in the next two years – the average values ​​for the S&P 500 here are plus 5.7 percent and plus 10.5 percent, respectively.

It is true that oil companies’ profit margins can increase enormously in times of high oil prices – as is currently the case. However, this can quickly reverse again when energy prices drop again. In addition, the energy sector as a whole offers little growth potential. Therefore, the low valuation of the oil companies should also be treated with caution, because the shareholders do not calculate any growth that would reduce the P/E ratio in the long term. This process has been observed in technology stocks such as Amazon or Microsoft in recent years: Although these stocks have always been very expensive, the strong company figures have repeatedly confirmed – or even exceeded – these high valuations. The result: the performance of the technology sector left the broader market far behind. There’s a lot of debate going on about whether there’s going to be a major reversal into value stocks given higher interest rates and the continued high valuations of many tech stocks. Although this thesis has been impressively confirmed in the past few months, it is doubtful whether this sector rotation will continue with such dynamics. Because the technology stocks are likely to outperform the energy stocks in terms of growth in the future.

Conclusion: investment in the energy sector still profitable?

Overall, an investment in the energy sector seems worthwhile: The companies are still significantly cheaper than the overall market, they benefit enormously from the high energy prices and ensure stable dividend payments. The energy stocks can therefore continue to be viewed as a rock in the surf, especially in times of inflation, as a hedge against high volatility. While earnings expectations for many companies in the S&P 500 have been downgraded, analysts are expecting big increases for energy companies this year.

However, given the energy sector’s limited long-term growth prospects, investors need to be aware that the trees are not growing for the sky: while there is still a good chance that the energy sector will continue its bull run. But over the long term, other sectors may be in a better position, as analysts give energy companies little long-term growth opportunity. In addition, the performance of oil companies is highly dependent on future oil prices.

Editorial office finanzen.net

This text is for informational purposes only and does not constitute an investment recommendation. finanzen.net GmbH excludes any claims for recourse.

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