Are You Better Off Holding XLE Instead of Energy Stocks?

During its last conference call, Royal Dutch Shell (RDS.A) did the unthinkable for a major oil stock — it gave a huge profit warning.

energy-stocks-rds.a-xleOverall, Shell now expects its earnings to plunge by more than 48% for the quarter to reach just $2.9 billion in profits. Analysts had expected RDS stock to post a profit of roughly $4.9 billion for the final quarter of 2013. The full year numbers aren’t too great either — about $11 billion less than it earned in 2012.

Needless to say, the market wasn’t pleased by the warning, and RDS stock was hit hard.

The issue at hand for RDS stock can be summed up in two words — higher costs. Shell’s case isn’t unique among the world’s largest energy stocks, either.

As the major energy stocks have struggled with falling production and reserve values, they’ve been forced to dive deeper offshore and into more challenging environments to gain meaningful production numbers. Those unconventional sources of supply continue to get more expensive to tap, leading to squeezed margins per well … even as oil rises to the $100 per barrel mark.

And given the sheer size of the Exxons (XOM) and Chevrons (CVX) of the world, finding cheap sources of energy that will really move the needle in terms of production — and ultimately, share prices — is quickly becoming a losing battle.

All of this raises the question — should you even bother with the major energy stocks, or seek greener pastures in some other oil patch?

The Tale For The Major Energy Stocks Is In The Tape

The major energy stocks have been great performers over their long histories. For example if you bought $35,000 worth of XOM at the start of 1980, you’d be a millionaire today (assuming you held all your shares). However, the key thing to remember is that Exxon was a much smaller firm when it started out. Growth is much easier to come by when you’re not carrying around a $416 billion market cap.

And with behemoth sizes of energy stocks today, it takes some pretty big excitement and new reserves/production to move the needle and provide that kind of total returns for shareholders. One to two percent production increases — when they can find them — isn’t going to cut it.

Which is why the performance of major energy stocks has mellowed out in the past five years.

Comparing the major oil stocks to the popular Energy SPDR (XLE), the tale isn’t pretty. The XLE has managed to beat Shell and crush Exxon in the returns department. XLE has a five-year total return of 96.6% — compared to 87.7% for RDS.A and 41.7% for XOM. The results are similar with other big-time energy stocks like Chevron and BP (BP).

The key for the exchange-traded fund’s (ETFs) outperformance has been in what firms the XLE actually holds.

Yes, the XLE does include the major U.S. oil stocks- including XOM & CVX. However, the XLE holds plenty of mid-cap and smaller large-cap stocks in its arsenal. Firms like Range Resources (RRC),  Southwestern Energy (SWN) and EQT (EQT) have really just begun their long-term growth cycles, and smaller incremental gains in their production and reserves mean a lot more to them than XOM. Already, some analysts have called the “peak” in increasing organic production at the major energy stocks.

Thinking of it another way, these are the Exxons of tomorrow, and their production gains are similar to what XOM did during its heyday.

That fact has helped these smaller energy firms’ share prices surge higher than the larger and plodding majors. That should continue into the future as major oil stocks are forced to continue drilling deeper and more expensively to meet their production goals.

Should You Still Hold Major Energy Stocks?

Given their size and newfound continued underperformance, investors looking for growth may want think about passing on the major energy stocks and look towards smaller rivals like EOG Resources (EOG). Odds are you’re most likely significantly overweight in XOM and CVX stock anyway.

However, the majors do offer something special — high dividend potential.

XOM and CVX are cash flow machines. Those hefty cash flows have continuously made their way back to shareholders via dividends and share buybacks. Low payout ratios and a long history of dividend increases on their book, the long term at Exxon and Chevron will be paved with rising dividend checks to patient shareholders.

Just keep in mind these “reasonable priced” bond-like stocks aren’t going outperform the broad energy indexes.

Or you could just buy the XLE or similar energy-focused ETF and get the best of both worlds.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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