Even if you’re not at all interested in Whiting Petroleum (NYSE:WLL) or in the oil industry in general, you’ll want to read this article. If I may be blunt, most of the discussion centering around WLL stock focuses on it being a dangerous investment. But the more interesting question is why it’s so dangerous. Answering this will reveal a fundamental reality behind all investments.
First, I want to emphasize that WLL stock is indeed a risky play. As InvestorPlace contributor Laura Hoy described it, Whiting is “pointless” for most investors. Obviously, the company is bankrupt. Typically, there’s a reason for that and it’s rarely if ever a good one. As well, when the firm eventually emerges from bankruptcy, stakeholders will only receive 3% of the newly reorganized entity.
Of course, Hoy is using descriptive language. In the investing world, nothing is truly pointless until the asset price falls to zero. Right now, shares are trading well above zero. Which means a market exists between buyers and sellers.
Assuming we’re talking about rational actors – irrational actors could be at play but that’s an entirely different discussion – someone out there believes that buying WLL stock today will yield a profit in the figurative tomorrow. So, what’s the basis for this demand?
Fundamentally, the best explanation is speculation toward rising prices. The best evidence comes in the form of extremely bullish sentiment in early June. That was when the federal government released better-than-expected results for the May jobs report.
Logically, with employers calling back their workers or rehiring following the initial devastation of the novel coronavirus, this dynamic implies higher demand for oil. And that provides a much-needed catalyst for Whiting Petroleum.
Why the Math Fails WLL Stock
In a pivotal scene from The Wolf of Wall Street, Matthew McConaughey’s character Mark Hanna explains to Jordan Belfort, played by Leonardo DiCaprio, the real facts behind the investment markets.
To play it safe, I won’t link to the scene. Frankly, it contains almost every fire-able offense you can imagine. But in a nutshell, Hanna states that nobody knows whether a stock is going to go up, down, sideways or in flippin’ circles.
I agree in the sense that all investments involve the unknown. Typically, the more unknowns exist, the higher the reward potential. But investors can mitigate this risk – it of course can never be fully eliminated – by anchoring an investment thesis to a broader, and therefore more reliable index.
In the case of WLL stock, this anchor is oil demand. Recently, I discussed the speculative rationale supporting Marathon Oil (NYSE:MRO). Here, I juxtaposed MRO shares with the average monthly sales of U.S. gasoline stations. Performing this exercise, I noted that the price of MRO dropped far steeper in magnitude than demand for gasoline.
Assuming a return to normal – and this is a huge assumption – MRO is mathematically undervalued.
Now, if I were to perform this analysis on WLL stock, you might presume that Whiting is even more undervalued. But that’s not the case.
You see, with Marathon, the correlation coefficient (or what I would term the correlation “strength”) between MRO and gasoline demand is 47% between 2015 and May 2020. This is a weak correlation but a correlation exists nonetheless.
But for WLL stock, the coefficient in the same period is negative 2.7%. In other words, there is absolutely no significant statistical relationship between Whiting and gasoline demand. It’s unanchored from its core industry, making it a true gamble.
What’s the Point?
I don’t know anything about sports betting. Therefore, as a rule, I don’t bet on sports.
However, every now and then, I’ll bet just for the fun of it. One of the dumbest bets that I took was an extremely low-probability wager that the San Diego Chargers would win the Super Bowl. To tell you how much I know about sports or how little I care, the Chargers aren’t even in San Diego anymore.
That said, there’s a point to buying WLL stock. You’re betting that the equivalent of me in the investment markets – someone who does zero research, for one thing – is silly enough to acquire shares. With enough of these folks, and perhaps a surprisingly positive economic data point to boot, Whiting could fly higher.
However, the problem with this “logic” is that we don’t have a great way to assess the collective nuances of human psychology that would drive an investment like WLL stock. If Whiting was tethered to oil demand, that’s one thing. But as I just demonstrated, Whiting is unanchored, and that’s what makes it so dangerous.
A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare. As of this writing, he did not hold a position in any of the aforementioned securities.