Market Overview

Energy ETFs: A Credible Value Destination

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Energy ETFs: A Credible Value Destination
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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.

What Happened

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.

What's Next

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.

Related Links:

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