The death of the internal combustion engine has been greatly exaggerated. At the very least, it won’t be fully dead for decades. Meanwhile, demand for fossil fuels is still strong. 2020 was a catastrophe on that front because the whole world simply stopped working for months. Even now we are only partially back and won’t be at 100% for a while. For the short term, consumption will remain weak putting a lid on the price of oil. Until we stifle the pandemic, oil stocks will remain on their heels.
This, however, doesn’t mean that we can’t invest in oil companies now. Sure, earlier this year, experts called the sector dead. They theorized that there would be mass collapses. Not even the largest companies were safe from that prediction. But clearly they were wrong, because here we are today, still discussing investing in them. My point is that we should all own a bit of oil stocks for fixed income.
I acknowledge that we have to be selective, because there are a lot of potential junk companies. Some balance sheets are too risky to trust. These are the potential tape bombs on Wall Street. I will keep the ideas simple today so as not to bury us in the details. My common theme revolves around interest rates. The central bank actions made it so that there is no fixed income available to investors in the bond markets. Therefore, by default, companies that do pay a dividend are an alternative to investing in bonds. This forced a whole segment of money to chase risk in stocks.
There is a big elephant in the room, and that’s ESG (environmental, social and governance) investing steering money away from fossil fuels. I applaud the cause, because it is important to take care of our planet. However the threat is not tangible to the energy stocks for decades. We are still too dependent on them. Even when we charge our electric vehicles (EVs), we are still using fossil fuels in part.
This year’s EV craze is at full tilt, but not all EV stocks will be winners. Case in point what happened to Nikola (NASDAQ:NKLA) and Hyliion (NYSE:HYLN). More of them will join the failed stocks — and by that, I don’t necessarily mean bankruptcies. Sometimes companies don’t do well on Wall Street but can still carve themselves a nice niche off the board. Not every story there is going to be like Tesla (NASDAQ:TSLA) or Nio (NYSE:NIO). These two are special case stocks and there won’t be replicas of them especially TSLA.
Investors need to own a little bit of today’s three stocks. They are:
Oil Stocks to Buy: Chevron (CVX)
For a long while, I’ve favored CVX stock over Exxon. For some reason, it often trades better on Wall Street. While they are both in similar fundamental situations, the chart is more constructive. Case in point, CVX has gained twice as much off the Covid-19 low as XOM stock.
There are other fundamental nuances. For example CVX has a cheaper price-to-earnings ratio, but its price-to-sales is almost double. That is proof that there are a lot of investors like me who expect more from it. This could turn out to be a negative in case we get another selloff. Else, I bet CVX maintains its advantage over its main U.S. competitor.
The downside of having a better stock means that Chevron pays a lower dividend yield. But at 6% it is still mighty impressive.
The other good news, and that goes for both companies, is that its dividend is sacrosanct. Managements have committed to maintaining the payouts and they stuck to it. They did this by cutting their capital expenditure line items. This usually would be a problem for future growth indicating stagnation. But these are mature companies where investors are not seeking that from them.
Exxon Mobile (XOM)
Lately, XOM stock has shown some relative strength but it is still the one lagging. As a result it yields 8.4% which is an insane carrot for investors to own shares. Those seeking fixed income would have a hard time resisting such passive rewards.
Of course there are three main risks chasing almost two digit yields. First, the viability of the company but that’s not an issue here. Second are the odds of cutting the payout. And this year management has kept its promises to uphold it at all costs. They have earned my trust in that. Third is a material change in the XOM stock price. Specifically, the worry is if it hit another bearish stint. Then the loss of capital in the investment would more than offset the dividend gains. To that, the odds favor shallow dips going forward.
2020 was as tough a test as they come, so it will take incredible events to outdo it. The team successfully navigated the global shut down without cutting one penny out off the dividend. That earns major trust points in my book.
If the malaise continues, then there will be more small company failures. This won’t hurt the giants — it may even help them. Companies like XOM will benefit from fire sales from dying companies. They could even increase market shares. There is little excitement around owning this stock, but sometimes quiet is good. In this case, all I want it to do is pay me my yield and hold its value. The trailing price-to-earnings ratio is over 50 but this is a special year. Besides there is little froth in the stock price so the owners of it are realistic.
Energy Select Sector SPDR Fund (XLE)
The XLE chart closely resembles that of CVX. Therefore the arguments earlier also apply here. Besides, the two companies we discuss today make up almost 45% of that wholeexchange-traded fund, or ETF. This greatly reduces the risks from the fringe members who carry higher risks of defaults.
Usually one of the arguments to choose investing in ETFs instead of individual stocks is to diffuse single-stock risks. In this case, it’s the opposite. Consider that the next two largest components, ConocoPhilips (NYSE:COP) and Schlumberger (NYSE:SLB), are 5% each. But even they were in touch-and-go mode a good part of the year.
Owning XLE shares accomplishes the same goal of having fixed-income investments. But in this case, I would rather be a purist and invest in either Chevron or Exxon, not the ETF. I know their ins and outs better than the collective. I want to avoid any shadow of doubt from other potential balance sheet issues. Moreover, I can’t trust smaller company managers being as competent as these two.
On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Nicolas Chahine is the managing director of SellSpreads.com.