Finding Value With Energy ETFs

With the current bull market getting older each day, some investors are apt to believe finding value is becoming an increasingly difficult task. While many sectors are not alarmingly stretched on valuation relative to long-term averages, some are and finding those that are attractively valued against long-term metrics is not easy.

The sectors frequently cited as credible value plays these days are energy and financial services, perhaps explaining why those two groups are often found among the largest sector weighs in exchange traded funds following the value factor.

There is some debate regarding the energy sector's efficacy as a value play. Naysayers would point to the sector's contracting earnings, which serve to lower valuation metrics, as the reason the group looks like a value bet. Of course, decreasing earnings are not attractive at all and that scenario could indicate more value trap than legitimate value.

Still, the Energy Select Sector SPDR XLE, the largest equity-based energy ETF by assets, is higher 16.9 percent year-to-date. That puts XLE slightly behind the Utilities Select Sector SPDR XLU for the title of 2016's best-performing sector SPDR ETF.

On a technical basis, there very could be value to be had with XLE and some of its holdings.

“The energy sector’s recent performance, combined with the fact that none of these stocks are trading above a longer-term moving average, indicates there may be some value to be extracted from the oil patch. This may be especially true for long-term investors who can stomach the volatility,” said State Street in a recent note. 

Indeed, data suggest the energy sector, the seventh-largest sector allocation in the S&P 500 at a weight of seven percent, is attractively valued. Perhaps more so than all but one sector.

“The energy sector remains the second most inexpensive segment among the ten major S&P 500 sectors, based on the relative valuation measure: the price-to-book (P/B) ratio. As shown in the chart below, the energy sector P/B ratio is currently 30% less than that of the S&P 500, and it is close to its 10-year low,” adds State Street.

With second-quarter earnings season winding down, some analysts are forecasting that the quarter will be the fifth consecutive of year-over-year earnings declines for the S&P 500, with energy being a big reason why. Strip out energy for the second quarter and S&P 500 earnings were probably flat.