After the multi-year rally, broad U.S. benchmarks look fairly valued if not pricey. Nevertheless, investors can still find potential opportunities in energy sector exchange traded funds.
“Most sectors appear to be either fairly or modestly overvalued at present,” writes Ben Johnson, director of global ETF research for Morningstar. “However, the late-2014 downdraft in oil prices appears to have created a potential opportunity in the energy sector. ”
When comparing the energy sector’s price-to-earnings, price-to-book and yields to historical averages, oil-related stocks are trading at the lowest valuations in the current market.
For instance, the Energy Select Sector SPDR (NYSEArca: XLE) has a 1.87 price-to-book, compared to its 2.18 trailing 10-year average, along with a 14.99 price-to-earnings, compared to its 12.86 trailing 10-year average. Meanwhile, the S&P 500 index has a 18.42 P/E and a 2.57 P/B. Morningstar calculates that XLE was trading at a 6% discount to its aggregate fair value.
The Energy Select Sector SPDR ETF includes a broad group of oil-related companies, including integrated oil & gas 32%, oil & gas producers and explorers 29%, equipment and services companies 17%, storage and transportation 10% and refiners 10%. However, the fund is top heavy, with a 15.6% tilt toward Exxon Mobil (NYSE: XOM) and 12.8% in Chevron (NYSE: CVX), but the two firms operate in a diverse set of businesses across the energy space.
“The fund represents an inexpensive and efficient way to invest in the U.S. energy sector without assuming too much idiosyncratic risk,” Johnson said.
Potential investors should be aware that XLF also includes significant exposure to explorers and producers, which experienced heightened volatility in the recent sell-off. [Shale ‘Fracklog’ Could Cap Gains in Energy Sector, ETFs]
“These firms face myriad risks, including commodity price volatility, exploration risks, operational risks, and political and regulatory scrutiny,” Johnson added.
Looking at the long-term, oil services companies could grow increasingly more important as the industry taps into hard-to-reach regions, such as deep ocean waters and Artic tundras, to extract the diminishing resource.
Alternatively, investors can also consider the Vanguard Energy ETF (NYSEArca: VDE) and Fidelity MSCI Energy Index ETF (NYSEArca: FENY). Both VDE and FENY have a cheaper 0.12% expense ratio, compared to XLE’s 0.15% expense ratio. The Vanguard and Fidelity offerings also track a similar diversified group of energy companies, with similar top heavy tilts. However, XLE remains the go to choice for large and active traders, with a heavy average volume of 19.0 million shares, compared to VDE’s average volume of 396,000 and FENY’s average 190,00.
For more information on the energy sector, visit our energy category.
Max Chen contributed to this article.