Why Oil Stocks Are Still Good Value

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The oil price has been highly volatile in recent years, but overall it has seen a downward trend. That reflects the increase in alternative sources of energy and fears that demand for oil will fall. It has also not helped that some large oil producers like Saudi Arabia have faced economic pressures due to the falling price, so have added extra capacity, which in turn has led to even lower prices. Unsurprisingly, oil stocks have fallen in lockstep with the shrinking oil price. Oil stocks can represent good value even in these times of lower oil prices, however. Here we’ll explain why.

Oil Companies Are Well-Run Businesses

Large oil majors have decades of deep business experience and skilled management. Most sectors face demand and pricing changes over time, and what counts is not that that happened, but how management deals with it. As oil majors have skilled management, they are able to cope with even dramatic swings in demand and price. Companies like Exxon, BP and Shell have close to a century of doing business in some of the toughest environments and political climates on earth. That means that they have developed a resilience and ability to thrive against the odds which will hold them in good stead now as always.

Demand For Oil Will Keep Rising

To believe oil companies in general are not valuable, you need to believe that in the future people won’t be willing to pay much for oil. That seems to be a stretch at the least. It is true that there has been a lot of effort put into developing alternative sources of energy. However, the demand for energy is increasing a lot as countries across the world industrialise more and people have more disposable income. In addition, the world population has been adding millions every week for years, all of them now energy consumers. Oil is a proven and known energy source around which a lot of the world’s infrastructure is designed. So, the claim that oil demand will peak soon and then tail off is highly speculative and at odds with observed facts to date.

Business Challenges Are Priced In

Oil stocks have fallen a lot as the oil price has trended downwards. What that indicates is that the market has already priced into the stock bad news such as a lower price, the chance for the price to fall further in the future, possible supply imbalances and an increased takeup rate of alternative power technologies such as renewables. So, the price is unlikely to be significantly affected even if there is a continuous slow dripping of news which sounds potentially ominous for oil demand, because it has already incorporated that information. It may even be that this reaction has been overdone, driving prices lower than they ought to be. Over time, when the information is assessed more carefully and oil demand holds up, the overselling will reverse, which would support a price increase again.

The Dividends Keep Flowing

Whatever the health of the oil industry, no one is questioning the health of its payouts. Take ExxonMobil as an example. From 2008 to 2016, its annual dividend per share almost doubled, from $1.55 to $2.98. In the thirty four years to 2016, its annual payout increased by an average of 6.4% per year. Its paid out dividends every year since 1911 – over a century of continuous payments. Even when oil prices tanked in the 1970s, and during the Great Depression, Exxon kept sending dividend cheques to its shareholders. Nor is Exxon unique. Shell has raised its dividend annually since the end of the second World War over seventy years ago. Many other oil companies have long histories of uninterrupted payouts. This dividend history is one reason oil stocks are still good value – history suggests that they will go on making payments to shareholders year in and year out, decade after decade.

Oil Prices Are Only One Factor

Oil prices matter to oil companies but they are not the only thing that counts. Many oil companies have some degree of diversification. They extract oil upstream. But they also refine and sell oil downstream. Often this is through oligopolistic fixed networks of gas stations which gives them a significant degree of pricing power. They also have interests in non-oil energies, from gas to solar. Plus some oil companies continue to be involved in areas not directly connected to oil, such as finance, investment and transportation. This means that although investors have marked oil stocks down in line with falling oil prices, in fact their earning power is not solely dependent on the state of the oil market. There’s no doubt that tumbling oil prices have had an impact. That will to continue to be the case in the future, as it has been for over a century. But we have seen above that oil companies are often well run, diversified and reliable payers of dividends. That means that at today’s prices their stocks are still good value. If you are interested in good value stocks, take a few minutes now to look into the prospects of leading oil companies.