Mailbag: Are Energy Funds A Good Buy?

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Mailbag: Are Energy Funds A Good Buy?

Crude oil prices are relatively low. Exxon Mobil Corporation (XOM) has a P/E ratio of 12.30. Chevron Corporation (CVX) has a P/E ratio of 10.28.

Are energy stocks a good buy right now or will oil prices drop even lower?

– Enjoying the low price at the pump.

Oil companies such as Exxon Mobil and Chevron often move in sync with the price of oil. Here is the price of oil recently:

Crude Oil 2015-07-08

And here is the price of Vanguard Energy (VGELX) over the same time period:

Vanguard Energy (VGELX) 2015-07-08

You can see the similarity but the connection between the price of oil and the price of oil companies is loose. When people with little restraint think they know where the price of oil is heading, they buy or sell in anticipation of that price movement. This activity then changes the price of oil stocks, not because the speculators were right, but because a lot of them moved the same direction at the same time. Most of the time, they turn out to be wrong about the price of oil, but that doesn’t stop them from changing the price of oil stocks.

Most oil price predictions are essentially meaningless. All of the available data is already baked into the price of oil because investors have done whatever research can be done.

Most oil price predictions predict about half of whatever trend has been happening recently will continue. Probably, this gets analysts in the least amount of trouble with their superiors. If they predicted that oil prices are going to reverse their recent trend or double in strength, they might be right a little more often but would quickly lose their job when they are wrong. “Half again as much” seems safe when trying to predict what is essentially a random number. Unfortunately, this approach results in chasing returns, which is always a bad idea.

Better to set a reasonable asset allocation and then regularly rebalance back to it.

Energy companies can be a good component of a balanced portfolio because of their low correlation to bonds and other stocks. Their volatility does not need to be timed to achieve your financial goals. Although it may take a while for energy prices to recover, I think they are still a good investment.

Photo used here under Flickr Creative Commons.

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David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. Favorite number: e (2.7182818...)