What are we looking for?
Energy companies for investors erring on the side of caution
The screen
Although it seems the energy sector is on a tear lately, the inherently volatile price of oil might make it difficult for conservative investors to ride the trend. For investors who are interested in the space but want to err on the side of caution, today’s strategy seeks to find companies in the energy sector that exhibit stable characteristics relative to others in the sector (although still very much exposed to oil prices). To find these companies, I used Morningstar CPMS to rank the 101 energy companies in the database on the following metrics:
- five-year deviation of earnings and ROE (statistical measures outlining how volatile earnings and profitability are, lower figures preferred)
- one-year deviation of total return (similar to the above, this measures historical volatility in the stock’s price, lower figures preferred)
- five-year price beta (measures the historical sensitivity of a stock’s price to an index. A stock with a beta of less than one has historically moved less than the index in trending markets, which is preferred in this case)
- five-year average ROE (return on equity is a measure of profitability; here we take an average over the past five years, higher figures preferred)
Additionally, a screen was placed to ensure all qualifying companies have positive reported earnings per share.
What we found
I used Morningstar CPMS to backtest the strategy from January, 1999, to January, 2022, assuming an equally weighted 10-stock portfolio. Once a month, stocks were sold if they fell below the top 25 per cent of the index based on the above metrics, or if earnings turned negative. On this basis, the strategy produced an annualized total return of 14.5 per cent, while the S&P/TSX Energy TR index produced 9.9 per cent. Although the strategy employs stability metrics, investors are implored to remember that all energy companies are exposed to the price of oil, which will inevitably affect the stock’s price despite managements’ ability to manage risk. The stocks that meet requirements to be purchased into the strategy today are listed in the table above.
This article does not constitute financial advice. Investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
More about Morningstar
Morningstar Research Inc. is a leading provider of independent investment research in North America, Europe, Australia and Asia. Morningstar offers an extensive line of products and services for individual investors, financial advisers, asset managers, retirement plan providers and sponsors, as well as institutional investors. Morningstar Direct is the firm’s multi-asset analysis platform built for asset management and financial services professionals. Morningstar Canada on Twitter: @MorningstarCDN.
Ian Tam, CFA, is the director of investment research for Morningstar Canada.
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Ian Tam, CFA