Energy ETFs: A Credible Value Destination
The S&P 500 Energy Index is up nearly 6 percent year-to-date, or almost triple the returns offered by the S&P 500. Energy is one of just four sectors in the green this year.
The iShares U.S. Energy ETF (NYSE:IYE) is up 6.6 percent this year, while the iShares U.S. Oil & Gas Exploration & Production ETF (NYSE:IEO) has been even more impressive with a year-to-date gain of 14.6 percent.
Even with those notable performances and others, a strong case can be made that the energy sector is still a legitimate value play.
Plenty of exchange traded funds focus on value stocks that feature energy among their largest sector allocations. Various data points confirm energy's status as a value play.
“At two times trailing price-to-book (P/B) the sector looks cheap relative to its own history. Since 1995, the large cap S&P Energy Sector Index has traded at an average of approximately 2.4 P/B,” said BlackRock in a recent note.
IYE offers investors a basic, cap-weighted view of the energy sector. The ETF follows the Dow Jones U.S. Oil & Gas Index and holds 68 stocks, but over 36 percent of its combined weight is devoted to just two stocks — Dow components Exxon Mobil Corp. (NYSE:XOM) and Chevron Corp. (NYSE:CVX).
Why It's Important
When measured against the S&P 500, energy stocks look cheap.
“Energy stocks look even cheaper relative to the broader market. The sector currently trades at just 0.57 times the P/B of the S&P 500,” according to BlackRock.
“This compares favorably to the long-term average of 0.82 and the post-crisis average of 0.76. This is one reason energy stocks are currently over-represented in value indexes.”
Exploration and production names, a more volatile segment of the energy space, have been surging this year, as highlighted by the iShares U.S. Oil & Gas Exploration & Production ETF's showing. That fund devotes nearly 73 percent of its weight to exploration and production stocks, one reason why the ETF's three-year standard deviation of 26.44 percent is almost 700 basis points above IYE's.
Based on oil's current per barrel prices, energy stocks also look inexpensive relative to broader equity indexes — and underappreciated profitability bolsters the case for the sector.
“Measured by return-on-equity, profitability also explains about 20 percent of the variation in valuations. Based on this metric, energy companies appear about 10 percent too cheap,” according to BlackRock.
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