Are energy stocks still fairly cheap?

Energy stocks have outperformed the stock market — by a mile — this year. Record profits for oil and gas companies amid rising commodity prices have made the energy sector attractive to investors. However, record gains in energy and commodities stocks mask a weaker market for the S&P 500, where earnings growth has slowed markedly this year — and even diminishes if energy stocks are excluded.

Analysts say energy stocks are significantly cheaper than other sectors based on future year price-to-earnings (P/E) ratios. S&P 500 earnings growth in the second quarter was in high single digits. But excluding energy, profits actually fell year on year.

The outperformance of the energy sector thus masks stock market weakness and distorts the valuation tool many investors swear by – the forward P/E ratio.

Although the energy sector’s weight in the S&P 500 is only 2.7 percent, energy earnings account for a tenth of earnings growth as oil and gas stocks are the cheapest among the sectors by price-earnings ratios, James McIntosh, Senior Columnist at The Wall Street Journal, Notes.

S&P 500 Top Performing Power Sector

For the year to date, the energy sector has been the best performing sector in the S&P 500, according to market data Compiled by Yardeni Research.

The S&P 500’s energy segment is up 41.2% year-to-date through September 19. By comparison, the S&P 500 is down 18.2%, and all other sectors except utilities have also fallen since January.

In the energy sector, the integrated oil and gas sub-sector rose 47.6%, and the oil and gas exploration and production sub-sector jumped 46.5% amid tight supply, higher commodity prices, and expected energy shortages and rationing in Europe this winter.

Furthermore, equity strategists, portfolio managers, and retail investors grew Increasingly optimistic about energy stocks, shows the latest Bloomberg MLIV Pulse poll conducted earlier this month.

Related topics: US natural gas prices fall in rail deal, storage construction

The survey of 814 respondents — including retail and portfolio investors, risk managers, buy-and-sell traders, equity strategists, and economists — showed that two-thirds of all respondents aim to increase their exposure to energy-related stocks and bonds. over the next six months.

Excluding energy, S&P 500 earnings fell

However, record earnings for the energy sector mask a much weaker path to overall earnings for the S&P 500.

For the second quarter, the energy segment recorded the highest earnings growth of all 11 sectors at 299%, said John Butters, vice president and chief earnings analyst at FactSet, He said Last month. The S&P 500’s blended earnings growth rate was 6.7%, but if the energy sector is excluded, the S&P 500 would report a 3.7% annual profit decline instead of a 6.7% profit increase, accordingly. to FactSet.

For the third quarter, earnings growth has been down since June 30, and as of mid-September, the S&P 500 is expected to report annual earnings growth of 3.5%, compared to an estimated earnings growth rate of 9.8% on June 30, FactSet’s Butter said in earnings insight last week. The energy sector is the only sector that recorded an increase in expected earnings due to upward revisions to earnings estimates. As a result, the sector’s estimated annual earnings growth rate increased to 120.2% from 103.4% since June 30. The sector is also expected to be the largest contributor to earnings growth for the S&P 500 Index for the third quarter. If the sector is excluded, the index is expected to post a profit decline of 2.9% instead of a profit growth of 3.5%, says FactSet.

The next few weeks will show whether economic weakness will manifest itself in weak earnings in the S&P 500, Liz Ann Saunders, managing director, chief investment strategist at Charles Schwab, and Kevin Gordon, senior director of investment research at Charles Schwab, Wrote this week.

“In a few weeks, the third-quarter earnings season begins, with a lot of concern over whether this is the season where economic weakness translates into weak earnings. We believe the weakness in expected earnings growth early in its journey to an eventual negative point (a dip) annual) destination,” Saunders and Gordon say.

“FedEx news last week of an expected collapse in earnings and the company’s cancellation of all forward-looking guidance is likely.”

Last week, FedEx mentioned Quarterly numbers are lower than expected due to macroeconomic weakness in Asia and service challenges in Europe. Amid expectations of a continuing volatile operating environment, FedEx is withdrawing its fiscal year 2023 earnings forecast from June.

A weaker macroeconomic environment could mean additional cuts in earnings estimates for many companies in the S&P 500, while the energy sector continues to reap the rewards of higher oil and gas prices compared to last year’s levels.

This makes the forward P/E ratio more difficult to use as a valuation tool.

As Charles Schwab investment strategists said in their research, “Our goal in this writing is to emphasize that no single valuation metric serves as the holy grail of determining whether a market is a fair value.”

By Tsvetana Paraskova for Oilprice.com

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