After A Drubbing, Energy Stocks Remain Inexpensive

Even when energy stocks and the related exchange traded fund were rallying earlier this year, some analysts and market observers said the sector was inexpensive on valuation. Following a stretch that has seen the Dow Jones U.S. Oil & Gas Index lose almost 8 percent this month, some investors are renewing calls that energy is cheap.

Barring a further collapse in oil prices, ETFs such as the iShares U.S. Energy ETF IYE could draw renewed interest into the end of the year.

What Happened

The iShares U.S. Energy ETF, which tracks the Dow Jones U.S. Oil & Gas Index, was punished by oil's recent slide. That slide recently saw West Texas Intermediate futures notch their worst losing streak in 34 years. IYE is 15.68 percent below its 52-week high and is saddled with a year-to-date loss of almost 7 percent. Various data points highlight just how inexpensive the energy patch has gotten.

“Based on price-to-book (P/B) the energy sector is now trading at the largest discount to the S&P 500 since at least 1995,” said BlackRock in a recent note. “Energy stocks are currently trading at roughly a 50% discount to the broader market.”

Why It's Important

The $894.52 million IYE holds 70 stocks, but the ETF's price action is largely determined by just two of its holdings: Exxon Mobil Corp. XOM and Chevron Corp. CVX. Those Dow components, the two largest U.S. oil companies, combine for 38.62 percent of IYE's weight. Large weights to Exxon and Chevron are common among domestic, cap-weighted energy ETFs. Signs point to those and other names in the sector being as cheap as they have been in years.

“The sector also appears unusually cheap on an absolute basis. At less than 1.7x earnings, the current valuation is the cheapest since early 2016 and is in the bottom 5% of all observations going back to 1995,” according to BlackRock.

Given the sector's tendency to move in unison with oil prices, it's not surprising energy valuations decline as oil prices do the same. Conversely, valuations rise when crude prices do the same.

What's Next

Rising interest rates and an uptick in inflation could be among the macro factors that help the energy sector regain some of its lost luster.

“Historically, energy stocks have been more resilient than the broader market during periods of rising interest rates and/or inflation,” said BlackRock. “If part of what has dislocated the market this year is the prospect for higher rates and an overheating U.S. economy, energy stocks seem a logical hedge.”

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