Energy stocks and exchange traded funds endured a rough week last week as oil prices pulled back, but the sector remains a credible destination for value hunters.
The iShares U.S. Energy ETF IYE lost 3.17 percent last week, but remains higher by nearly 10 percent year-to-date.
What Happened
Last year, energy was one of the worst-performing sectors in the S&P 500. The sector's laggard status amplified calls that energy stocks were inexpensive relative to other sectors and some market observers offer data points confirming as much.
“The energy sector closed January at 1.7 times price-to-book (P/B) value,” said BlackRock in a recent note. “While this is roughly 10% above December’s multi-decade low, current valuations are still below the depressed levels witnessed in November and in the bottom 10% of historical observations.”
Why It's Important
IYE follows the Dow Jones U.S. Oil & Gas Index and holds 69 stocks. Like rival, cap-weighted energy ETFs, IYE is dominated by Dow components Exxon Mobil Corp. XOM and Chevron Corp. CVX. The two largest U.S. oil companies combine for just over 40 percent of IYE's weight. Exxon and Chevron are two of the 15 members of the Dow Jones Industrial Average that are up at least 5 percent year-to-date.
Even with the sector's strength this year and that of big-name stocks such as Exxon and Chevron, energy still looks attractively valued.
“On a relative basis U.S. energy companies continue to trade at the largest discount to the broader market since at least 1995. The P/B on the sector is about 50% of the broader market’s,” said BlackRock.
IYE's price-to-book ratio is 1.58 compared to 3.15 on S&P 500 ETFs.
What's Next
Energy stocks aren't just inexpensive compared to broader equity benchmarks, such as the Russell 1000 and the S&P 500, the group is cheap relative to oil prices.
“Historically, the price of oil has explained roughly 20% of the variation in the relative multiple of the sector,” according to BlackRock. “At $54/barrel, crude oil prices suggest the sector should be trading at an 18-20% discount to the market, not a nearly 50% discount.”
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