5 Charts You Must See Before You Trade Energy

By Chris Marasco - August 26, 2012 | Tickers: BP, CHK, CVX, COP, XOM | 0 Comments

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Not many organizations have been able to grow their assets more than 180% coming out of the recession.  But the Fed has.  While banks have been slicing and dicing their balance sheets, the Fed has ballooned its assets from less than $1 trillion before the recession to a whopping $2.8 trillion near July’s end.  Go ahead and take a look inside the Fed’s balance sheet.  Scary.

Talk of QE3 is hitting the markets, and investors are just as unsure of whether the markets will rise or fall as they are of whether the dollar will rise or fall against commodity currencies, emerging currencies, or the dreaded euro.  The culprit for the uncertainty?  Inflation.

If we do see inflation, it is likely to prop up asset prices, commodities in particular.  So investors hoping to hedge their portfolios would be wise to enter commodity prices at pullbacks and hold for longer-term swings.

What is my favorite commodity to play?  Oil – and you can trade it in a number of ways.  The futures and ETFs that track the futures are one way, but for investors who have different portfolio goals, there are also ways to track oil using stocks.  It is called correlation – how closely two asset pairs track each other.  If oil and Asset XYZ both rise in lockstep, correlation is 1.0.  A correlation of -1.0, on the other hand, means that both securities move in lockstep – but in opposite directions.

Below are five major oil companies that investors may wish to have in their portfolio, how they each correlate to the price of crude, and each firm’s dividend yield and fundamental factors. 

Inputs

• Charts below are compared to /CL, the front month oil futures.
• I used a correlation length of 50 – meaning that the correlation line compares the price performance for the two underlying securities using prices from the past 50 trading days (roughly 2.5 months).  A longer duration gives a more accurate correlation because it makes for more smooth lines (think 10-day simple moving average versus a 50-day moving average - the 50 is smoother).

Exxon Mobil (NYSE: XOM)

Exxon Mobil is one of the world’s most valuable companies with a market cap of $405.8 billion.  The Texas-based company has an astounding 29.02% return on equity and has grown year over year quarterly earnings by 49%.  Also, the company sports a 2.6% dividend yield. 

Chesapeake Energy (NYSE: CHK)

Chesapeake is most known for natural gas, but is also a Top-15 producer of crude.  A high point of Chesapeake is that it increased its operating margins to 22.5% and grew year over year quarterly earnings an astounding 90.6%.  The company’s 1.8% dividend is strong, especially considering that the firm only pays out 9% of its earnings as dividends.  Finally, Chesapeake trades at a measly 6.4 times earnings. 

Do look hard at Chesapeake’s low .43 correlation to oil.  This is likely due to the leverage and volatility that Chesapeake is known for, making its correlation far less predictable.

BP PLC (NYSE: BP)

BP has recovered nicely from its disastrous oil spill, and it pays out 4.5% as a dividend.  Downsides include the firm’s low profitability ratios – the firm has a 6.15% operating margin and a 4.2% profit margin.  Nonetheless, this company is on my watch list in case the market takes a nose dive.

ConocoPhillips (NYSE: COP)

ConocoPhillips rocks a 4.6% dividend yield and a price to earnings of just 6.7.  The company’s margins are low at 9.4% for operating and a 4.8% profit margin, but I like the firm’s 20.3% return on equity.  On the downside, the company shrunk its quarterly earnings 33.4% year over year.  This could potentially be detrimental to the dividend because ConocoPhillips pays out 31% of its earnings – if ConocoPhillips has another disappointing quarter, it may be time to put this stock on the backburner for a while.

Chevron (NYSE: CVX)

Chevron has nice operating and profit margins of 16.5% and 11.3%, respectively.  Also, the company has a 21.6% return on equity and a 3.2% dividend yield.  Finally, I like that Chevron holds nearly $21.5 billion in cash.

To conclude, I expect inflation to eventually rear its head.  How can investors hedge it?  First, look to commodities.  They often rise as investors dump new money into them during inflationary periods.  Second, find companies with strong pricing power that pay nice dividends. 

The five companies above lead their industries and pay out dividends that should increase right along with their earnings.  My favorite of the bunch is BP, which pays a strong 4.5% dividend and has a nice .937 correlation with crude.

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