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Aug. 25, 2022, 6:24 p.m. EDT

Here are 5 reasons why energy stocks look like a buy despite rising 74% in a year

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By Joseph Adinolfi

Stocks in the S&P 500’s energy sector still have plenty of upside despite their 74% surge in the past 12 months, according to Jeff Buchbinder, chief equity strategist at LPL Financial.

The strong rally in energy shares, including those of oil giants Exxon Mobil Corp /zigman2/quotes/204455864/composite XOM -3.00% and Chevron Corp., /zigman2/quotes/205871374/composite CVX -2.91% compares with a 6.6% drop for the broader S&P 500 index /zigman2/quotes/210599714/realtime SPX -1.54% from a year ago, with energy and utilities helping offset blistering losses in other parts of the index.

While focus this summer briefly shifted to a rebound in shares of information technology, consumer discretionary and other “growth”-oriented sectors, energy now appears to be back on a path (see chart) higher.

Buchbinder said this dynamic should continue, despite energy stocks being a “controversial investment for some,” in emailed comments Thursday. He also hasn’t been alone in his bullish call, with JP Morgan Chase & Co.’s equity research department and others on Wall Street calling out energy’s potential upside.

Here are five reasons why LPL thinks energy stocks are a “buy.”

Improving outlook

Sector fundamentals tell a compelling story. China’s economy has been reopening from this year’s COVID-19 lockdowns, while droughts have hampered production of hydroelectric power.

What’s more, positive signs of a potential accord to allow Iranian crude to flow freely again on the international market could be offset by production cuts from Saudi Arabia . As trader weighed the potential for an Iran deal, West Texas Intermediate crude for October delivery /zigman2/quotes/211629951/delayed CL.1 +0.34%  fell $2.37, or 2.5%, Thursday to settle at $92.52 a barrel on the New York Mercantile Exchange.

Technicals also look better

LPL’s Buchbinder pointed to several technical factors that could bode well for energy stocks. First, the sector remains in a long-term uptrend, as it has been trading just 10% shy of its all-time high in June. Breadth also has been strong, with more than 90% of stocks in the S&P 500 energy sector trading at 20-day highs, as of Aug. 23.

Finally, should the energy sector return to outperforming the rest of the S&P 500 by the same degree it did during the first half of the year, this would translate to 20 percentage points of relative outperformance, he said.

Strong earnings momentum

Energy was the clear winner of the second-quarter earnings season. Not only did energy generate the most earnings growth, it’s still on track to lead the S&P 500 in earnings for the year, according to Buchbinder. The sector also saw the most upward earnings revisions to 2023 earnings expectations.

Strong earnings have increasingly supported share repurchases and dividends.

Valuations reflect pessimism

To be sure, one reason energy stocks tend to trade at lower valuations is because nobody can say for sure where oil and natural-gas prices are headed.

But if one assumes that prices will be stable, or higher, in the next several quarters, then the valuation of energy stocks looks pretty compelling, Buchbinder said.

/zigman2/quotes/204455864/composite
US : U.S.: NYSE
$ 109.81
-3.40 -3.00%
Volume: 23.01M
Nov. 28, 2022 4:03p
P/E Ratio
8.95
Dividend Yield
3.31%
Market Cap
$466.23 billion
Rev. per Employee
$6.20M
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/zigman2/quotes/205871374/composite
US : U.S.: NYSE
$ 178.36
-5.34 -2.91%
Volume: 9.35M
Nov. 28, 2022 4:03p
P/E Ratio
10.15
Dividend Yield
3.18%
Market Cap
$355.21 billion
Rev. per Employee
$5.36M
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/zigman2/quotes/210599714/realtime
US : S&P US
3,963.94
-62.18 -1.54%
Volume: 0.00
Nov. 28, 2022 5:22p
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/zigman2/quotes/211629951/delayed
US : U.S.: Nymex
$ 76.54
+0.26 +0.34%
Volume: 388,889
Nov. 28, 2022 4:59p
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