A Market-Beating Oil Basket Bet

 | Sep 28, 2016 | 2:43 PM EDT
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Stock quotes in this article:

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Back on Jun. 7, I recalled the famous trade Sir John Templeton made back in 1939. In the midst of a market meltdown, Templeton bought $100 of every stock trading below $1 on the New York and American stock exchanges. He paid about $10,400 for this basket of 104 companies, of which 34 ultimately went bankrupt. However, Templeton still managed to sell the rest four years later for more than $40,000 -- or a roughly 300% return.
 
Templeton, whether he realized it or not, created what might be referred to as a basket bet. Essentially, buying a basket of similar stocks is an intelligent way to bet on a particular category without the exposure of one particular stock that may or may not work out. Years back, Warren Buffett made this type of trade with South Korean stocks. Seeing that Korean stocks were trading for low single digit price to earnings ratios, Buffett looked through a stock manual and created a basket of the more-attractive ones. Not having an edge in Korea, Buffett was simply betting that such cheap valuations would rise over time -- and that by owning a basket, he would benefit from that viewpoint.
 
In my Jun. 7 column, I suggested creating a basket of oil stocks. Many energy stocks were trading for a fraction of what they used to, given the pounding that the segment has taken. And it was likely that some oil-and-gas firms would either go bust or face slow, painful declines, while others would probably see their share prices rise to several multiples of current levels.
 
The names I suggested to include in the basket seem to be working as you might expect -- some huge winners, a few laggards, but overall a better-than-average result.
 
Chesapeake Energy (CHK) is up about 50%;  Comstock Resources (CRK) is up 50%;  Exco Resources (XCO) is down 3%;  Bellatrix Exploration (BXE) is down 10%;  Kosmos (KOS) is up about 4.5% and  Memorial Production Partners (MEMP) is down 22%.
 
Since a basket bet is equally weighted by dollar amount, this group of stocks is up approximately 12% over the past three and half months. The Energy Select Sector SPDR ETF (XLE) is down nearly 3% over this timeframe -- and most other energy-related ETFs are down as well. The basket approach has crushed its benchmarks. Even the S&P 500 is up only around 3% during this time.
 
Templeton's trade was a gift to investors. Smart investors utilize this basket approach all the time, because it works -- when implemented correctly and patiently.

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