Making a Bet on the Oil Patch

 | Nov 04, 2013 | 12:20 PM EST
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An industry that for decades has experienced turmoil, nowadays seems almost calm and steady. That industry is oil. So commonplace was the turbulence in this industry, the phrase "oil shocks" entered the vernacular.

Whether it was the oil shocks of the 1970s, when gas lines formed throughout the country, or the shocks of the 1980s, when oil prices fell through the floor, to shocks of recent years, when unrest in the Middle East and elsewhere caused the price of a barrel of oil to reach upwards of $145, the industry seemed in almost continual motion and commotion.

Today, with fracking generating newfound sources of the black gold, a coup in Egypt, a change in command in Venezuela and a Syrian civil war (among other issues), one would expect the industry's turmoil to continue. But it hasn't. Oil prices are pretty steady at about $100 a barrel or less, prices at the pump are high but not at panic levels, and the industry is generally doing well.

The focus of investors is often on the oil majors such as ExxonMobil (XOM) and Royal Dutch Shell (RDS.A), but smaller players are worth considering. A decade ago, I created a series of computerized strategies modeled after the techniques of some of history's greatest investors. I use these to find stocks to suggest. Right now, three mid-tier oil companies, with market caps in the $20 billion to $30 billion range, get approval from these strategies. All are worth a look.

Hess (HES) is involved with oil exploration and production, as well as marketing and refining, with operations in more than a dozen countries. My Peter Lynch-based strategy favors Hess. The primary variable that this strategy utilizes is the P/E/G ratio, which is price-to-earnings relative to growth and is a measure of how much the investor is paying for growth. A P/E/G of up to 1.0 is acceptable; Hess's yield-adjusted P/E/G is well below this at 0.62. In addition, the company has a moderate amount of debt.

Another Lynch favorite is Marathon Petroleum (MPC), which refines, markets and transports petroleum products primarily in the Midwest, Gulf Coast and Southeast regions of the U.S. Marathon's P/E/G is a very favorable 0.16, while its debt load is modest.

Valero Energy (VLO) is an important refiner and marketer of petroleum products. It has operations in the U.S., Canada, U.K. and the Caribbean. My James P. O'Shaughnessy strategy favors Valero because of the company's large market cap ($22 billion), EPS that have improved in each of the last five years and a price-to-sales ratio of 0.16, way below the 1.5 maximum allowed. Those companies that pass these three tests are then judged by their relative strength (a measure of how well a stock has done in past 12 months vs. the market), and the top 50 stocks get the strategy's highest grade. With a relative strength rating of 78, Valero is among these top 50.

The petroleum industry is enjoying a period of good profitability and relative stability. These companies are in solid positions to benefit from these circumstances.

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