As the price of oil spent the second half of 2014 dipping to below $55 per barrel from its perches above $100, energy stocks tanked like crazy, taking untold billions of dollars off the board.
The upside: These price changes to both commodities and energy stocks have opened plenty of opportunities for investors who are willing to do a little work and be patient.
We all know the saying “buy low, sell high,” and the fall in energy stocks has absolutely put this phrase into play.
Just don’t jump in eyes closed.
Before you start buying the dip in energy stocks — and you should — here are three things to keep in mind that will help you pick the right energy stocks, and know how to play them once you do.
Be Wary of What You Buy
Energy stocks are all connected in one way or another. If the price of natural gas moves higher, people and companies begin to use more oil or coal, and demand for solar panels jumps.
If a nuclear reactor explodes, politicians begin making it more difficult to build new nuclear power plants, causing coal and natural gas to rise.
When the price of oil falls, it might be less advantageous for truck drivers to switch over to natural gas vehicles, thus lowering the demand for natural gas, making it cheaper for homeowners to heat their homes in the winter. That chain reaction could then hurt the solar panel business, since homeowners are no longer being hammered by utility bills.
So with that in mind, in 2015 investors need to consider how one commodity affects energy stocks — even those that operate in a completely different side of the business. While in some cases energy stocks are beaten down for no concrete reason, investors shouldn’t jump in without being pretty sure a big dip came for “no concrete reason.”
Do your research and understand how outside influences could affect any of your target stocks moving forward.
Get Paid to Be Patient
It’s safe to say most investors believe oil will move higher sometime in the future. Of course, the problem is that we can’t accurately predict when that will happen, or the extent of such a move.
And hey, since no one knows when oil prices will move higher, or if they’ll fall more before said eventual climb … well, why not get paid for waiting?
A solid dividend yield can help offset an investor’s opportunity cost while waiting for a stock or whole industry to move higher. Many energy stocks pay hefty dividends, making it easy for investors to find yield during a bust cycle.
But remember: Not all companies with dividends have healthy dividends. Dividends typically are paid out from earnings, so if a company is too reliant on high oil prices to provide those earnings, low oil will hurt profits and thus could weigh on its regular cash distributions.
Thus, it’s key to find companies that are at least partially sheltered from commodity price fluctuations, or at least exposed to multiple commodities. I personally like multinational organizations such as Exxon Mobil Corporation (XOM) and Chevron Corporation (CVX), which are better protected against low oil prices thanks to their integrated operations and their exposure to both oil and natural gas.
Other places to look are energy MLPs with operations in pipelines, transportation and storage of both oil and natural gas.
While I full-heartedly believe now is the time to buy into energy stocks, I also think it’s important to buy into the sector slowly.
As I mentioned above, we have no idea when oil and energy stocks will rebound, or even whether they’re done falling yet. Therefore, building a position over the course of a few months rather than all at once will protect you against possible weakness in the future.
Buy a portion of your final position every few months over the next year. This will help lower your cost basis should oil continue to fall, but also keep you from buying all of your position “late” should a rebound start to emerge sooner.
When oil prices move highers, energy stocks will broadly benefit, as rising tides typically do lift all boats. But like most investment opportunities, time is essential, and waiting too long can mean you’ll be too late.
So the best strategy is to slowly start buying into strong companies that can withstand low oil prices while still paying healthy dividends. It’s no guarantee of success, but it’s the best chance you can give yourself.
As of this writing, Matt Thalman did not hold a position in any of the aforementioned securities.