Diverse, Efficient Energy Sector Exposure

The energy sector was one of last year's best-performing groups, but energy equities have scuffled a bit to start 2017 as oil prices have lagged. Concerns that some members of the Organization of Petroleum Exporting Countries may not abide by the cartel's output reduction plan are among the reason's oil prices are modestly lower.

Energy Exposure

Still, energy stocks offer some potential for investors, particularly as the sector shakes out of its earnings rut. Stocks in the Energy Select Sector SPDR (ETF) XLE posted revenue growth, on average, of 4.5 percent during the final quarter of 2016. All sectors notched revenue increases with the aggregate number for the S&P 500 checking in at 5.2 percent revenue growth, according to AltaVista data.

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XLE is the largest exchange-traded fund dedicated to energy stocks. The ETF is down 4.4 percent to start the year. Energy is a considered a cyclical, high beta sector. As such, XLE is usually more volatile than the broader market.

“For example, over the past 10 years, this ETF's standard deviation of returns of 22.2 percent is far higher than the 15.3 percent posted by the S&P 500. And XLE's three-year standard deviation of returns of 19.2 percent also far eclipses the 10.5 percent logged by the broad benchmark,” said Morningstar in a recent note.

ETF's Methodology, Strategy

XLE weighs its 39 holdings by market capitalization. The result is a roster dominated by just two stocks – Dow components Exxon Mobil Corporation XOM and Chevron Corporation CVX, the two largest U.S. oil companies. Those stocks combine for over 30 percent of XLE's weight. XLE's third- through ninth-largest holdings would need to be combined to arrive at a sum greater than the weight allocated to Exxon and Chevron.

On valuation, energy, the seventh-largest sector weight in the S&P 500, is regarded as one of a small number of sectors that currently reside below long-term average earnings multiple. Energy and financial services stocks often dominate ETFs that are dedicated to the value factor.

Something To Keep In Mind

Investors should remain mindful of the sector's inherent volatility along with production and capital spending trends.

“Ailing energy producers in the U.S. have reduced their upstream capital spending. Lower investment should mean less output, which over time could contribute to a rebalancing of the markets. In addition, less oil-directed drilling activity theoretically could mean lower growth in U.S. lower natural gas production,” said Morningstar. “And while it is far more difficult to place a probability on such events, a far more immediate impact on energy prices could come from some geopolitical event involving a major oil-producing nation.”