Are energy stocks always cheap?

Energy stocks are outperforming the stock market — by a mile — this year. Record profits for oil and gas companies amid soaring commodity prices have made the energy sector attractive to investors. Yet record earnings for energy and materials stocks mask a weaker S&P 500 market, where earnings growth has slowed markedly this year — it even flattened out when energy stocks are excluded.

Analysts say energy stocks are much cheaper than other sectors based on upcoming price-to-earnings (P/E) ratios. Second-quarter S&P 500 earnings growth was double-digit. But excluding energy, earnings were actually down year over year.

The outperformance of the energy sector thus masks the weakness of the stock market and distorts a valuation tool on which many investors swear: the price-to-earnings ratio.

Even though the energy sector’s weight in value in the S&P 500 is only 2.7%, energy earnings account for a tenth of earnings growth as oil and gas stocks are the cheapest among the sectors. in terms of P/E ratios, James Mackintosh, senior columnist at the Wall Street Journal, Remarks.

The energy sector is the best performer in the S&P 500

Year-to-date, the energy sector is the best performing sector in the S&P 500 index, according to market data compiled by Yardeni Research.

The S&P 500 energy sector had gained 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 lost ground since January.

Within the energy sector, the integrated oil and gas subsector jumped 47.6%, and the oil and gas exploration and production subsector jumped 46%. 5% amid tighter supply, soaring commodity prices and expected energy shortages and rationing in Europe this winter.

Additionally, equity strategists, portfolio managers and retail investors increased increasingly optimistic about energy stocks, the latest Bloomberg MLIV Pulse survey conducted earlier this month shows.

Related: U.S. natural gas prices plummet on rail deal, storage construction

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

Excluding energy, S&P 500 earnings are down

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

For the second quarter, the energy sector posted the strongest earnings growth of all 11 sectors at 299%, John Butters, vice president and principal earnings analyst at FactSet, said last month. According to FactSet.

For the third quarter, the earnings growth rate has been lowered since June 30, and in mid-September the S&P 500 is expected to show annual earnings growth of 3.5%, compared to the earnings growth rate. estimated at 9.8% as of June 30, according to FactSet. Butters said in a benefit Overview Last week. The energy sector was the only sector that saw an increase in expected earnings due to upward revisions to earnings estimates. As a result, the industry’s estimated annual earnings growth rate has risen from 103.4% to 120.2% since June 30. The sector is also expected to be the biggest contributor to S&P 500 earnings growth in the third quarter. If that sector were excluded, the index would be expected to show a 2.9% revenue decline rather than a 3.5% revenue growth, according to FactSet.

The coming weeks will show whether economic weakness manifests itself in weak S&P 500 earnings, Liz Ann Sonders, 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 will begin, with much hesitation about whether this will be the season where economic weakness translates into weak earnings. We believe that the weakness in expected earnings growth is at the start of its journey to an ultimate negative (year-over-year decrease),” Sonders and Gordon say.

“Last week’s news from FedEx of an expected earnings implosion and the company’s removal of all forward guidance is a likely canary.”

Last week, FedEx reported quarterly figures below its own expectations due to macroeconomic weakness in Asia and service problems in Europe. Amid expectations of a still-volatile operating environment, FedEx is withdrawing its fiscal 2023 earnings guidance starting in June.

A weaker macro environment could mean further downward revisions to earnings estimates for many S&P 500 companies, as the energy sector continues to reap the rewards of higher oil and gas prices relative to levels of the previous year.

This makes the forward price/earnings ratio even more difficult to use as a valuation tool.

As Charles Schwab’s investment strategists put it in their research, “Our goal in this article is to reinforce the fact that no single valuation measure acts as the holy grail in determining whether the market is properly assessed.”

By Tsvetana Paraskova for Oilprice.com

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