Oil and Energy Stocks: A Primer

May 8, 2009 by admin
Filed under: Stocks

No doubt it’s a golden age for oil and gas investments. True, oil and energy markets are as much a political issue as a financial one, but with both issues dominating the world scene, there is little doubt there is money to be made in the oil and energy markets – if you know what you’re doing.

The first thing to know about oil and energy stocks is that there is a lot more to them than you might think. Demand for oil is way up, especially in high growth economies like China and India. It’s also not just oil and energy developers. There is an ever-growing sub-sector of oil and energy services companies that investors can choose from – especially in the small-cap sector.

In fact, there are hundreds of companies to choose from and different factors to consider. Is oil excavation a good move? Alternative energy? Canadian oil mines? Off shore drilling companies? Companies that develop drill bits for oil developers? You get the idea.

Then it’s time to pop your green eye-shaded visor on and play financial accountant. Many oil stocks tend to get over-valued in the broader stock market – they attract a lot of money because oil companies make a lot of money (that’s less so for energy businesses, but not by much – any commodity that generates a great deal of consumer demand, like both oil and energy, is going to cause some investment traffic.)

Job one in your due diligence is to determine the real value of oil stocks. Start that process by examining the price/earnings ratio. That is critical because many oil stocks are traded at a value significantly higher than their actual worth The company’s intent might be honorable – a high growth strategy is not uncommon there – but the chances of making your money back are lessened when P/E ratios are out of whack.

A shift in the congressional power-base in the U.S. in 2007 accompanied by unprecedented media attention promises to keep the evils of carbon emissions and global warming on the front burner. As a result, “green” companies in the small cap universe are getting increasingly sought out and scrutinized on both Wall Street and Main Street. Is alternative energy finally ready for prime time? From an investment point of view, this question will be answered by the market – if the earnings aren’t there, then the market’s not there. Due diligence prior to acquiring a position is still the order of the day.

There is a good reason why investors long have referred to oil as “black gold.” It’s a tempting market to leap into willy-nilly, but resist that urge. Ditto the alternative energy sector, about which you’ll be seeing more in the months and years to come. In both instances your best shot still is to study the market, figure out which companies have the greatest value story, and act and invest accordingly.

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