Take a Shine to Oil

 | Dec 13, 2011 | 4:30 PM EST  | Comments
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Stock quotes in this article:

tot

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bp

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rds.a

If an industry's source of supply were to dramatically shrink, one would expect the industry to shrink as well -- or at least lose much of its relevance. Well, not if that industry is oil.

The Wall Street Journal reported that in 1970, Western oil firms had access to 85% of the world's oil reserves, while in 2010, this access had fallen to just 7%. National oil companies, from Saudi Arabia to Libya to Venezuela to Mexico, have taken control of oil reserves. But oil in the ground does not have much value. Reserves need to be developed, which requires money and expertise. This is why the major energy names remain relevant even while their control of oil has dropped.

The world still runs on oil and even the national oil companies will rely the major oil companies to help them develop and produce their oil. This and high oil prices that seem unlikely to drop dramatically any time soon account for how well the oil majors are doing, and why several get nods from my guru strategies.

I use strategies modeled after the writings of well-known guru investors to choose which stocks to invest in. Right now, they are gushing about several major international oil companies.

In addition to being one of the largest integrated chemical producers in the world, France-based Total S.A. (TOT) is among the largest integrated international oil companies.

I use a strategy based on James P. O'Shaughnessy's thinking, which is recommending Total. The company has several variables going for it that are all large enough to satisfy this strategy: its market cap ($120 billion), cash flow per share ($11.05), number of shares outstanding (612 million) and trailing 12-month sales ($213 billion). When all of these criteria are met, the strategy then finds the top 50 companies based on their dividend yield. Total's dividend yield of 6.22% places it in this select group of 50.

Meanwhile, British-based BP (BP) gets a nod from the classic contrarian strategy of David Dreman. It runs four tests, and if a stock passes at least two, it is considered a contrarian. The four tests are that the price-to-earnings (P/E), price-to-cash flow, price-to-book value and price-to-dividend ratios be in the bottom 20% of the market. As it happens, BP's P/E and price-to-cash flow ratios are in the bottom 20%. Of course, some companies are out of favor for good reason, so to be sure the company is on solid ground, the strategy looks at several other criteria. These include having a return on equity (ROE) greater than the top one-third of ROE from among the top 1,500 large cap stocks, which is 18.2%; BP's is a solid 23.4%. Another is having a relatively high yield and BP's yield is 3.93%, which is well above the market's yield of 2.84%. In addition, the company's pre-tax profit margins are a strong 9.61%.

British-Dutch oil giant Royal Dutch Shell (RDS.A) is, like Total, one of the O'Shaughnessy strategy's favorites. With a market cap of $226 billion, cash flow per share of $14.24, shares outstanding (3.1 billion) and trailing 12-month sales ($455 billion), it passes the strategy's first four tests. It is also among the top 50 stocks that possess all these criteria because of its 4.67% yield.

The oil patch is in a strong position today, and investing in these stocks means you are buying dominant players with solid financials. This is a good time to put some oil barrels in your portfolio.

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