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Elevator Pitch

I rarely invest in commodity businesses like oil companies but when I do I only invest when the downside is limited and the price is right. In the case of Exxon Mobil (XOM), I would consider adding a small speculative position to my portfolio if the price of oil was trading at about $60 per barrel. The position in Exxon Mobil would be initiated at a price of about $55 per share assuming that oil was trading at an estimated fair value (based on supply and demand) of about $60 per barrel. I would gamble that Exxon Mobil stock would double in about three years. However, I do very little gambling in my portfolio. I prefer to invest in high quality businesses possessing strong competitive advantages that are selling at attractive prices.

Thesis & Catalyst For Exxon Mobil Corporation

Exxon Mobil is an excellent oil company but oil companies are not excellent businesses. Oil companies are a commodity business where earnings are tied to the price of oil. It is my belief that oil prices are unpredictable and therefore the earnings of oil companies such as Exxon Mobil are unpredictable as well. I value predictability of earnings when selecting stocks for my portfolio. Without predictable earnings, it is almost impossible to determine the value of a stock. Therefore, buying stock in commodity businesses such as Exxon Mobil should be regarded as speculative in nature.

Occasionally, when the situation warrants action, I will add a small speculative position in a commodity business to my portfolio. For instance, I may speculate in a commodity business if the underlying commodity is selling at an attractive price relative to the average world cost of production or the conservatively estimated fair value of the commodity based on supply/demand factors. In the case of oil, the average world cost of production is about $30 per barrel and the fair value based on supply and demand factors is in the range of $55 to $65 per barrel. As I write this article, the price of oil is about $95 per barrel and the share price of Exxon Mobil is about $91.

Valuation

I would only be interested in speculating in Exxon Mobil stock if the price of oil came down to $60 per barrel or less and the price of Exxon Mobil stock was trading at $55 or less. Under these conditions, I would feel comfortable that the downside risks to the stock price are relatively limited while the upside catalysts of improving major economies and growing tensions in the Middle East would likely lead to much higher oil and Exxon Mobil stock prices in the near future.

I base my analysis on how Exxon Mobil stock has traded in the recent past when oil prices were in the range of $60 to over $100 per barrel with adjustments for share buy backs, dividends, and cash position. I have chosen to ignore the severe drop in oil prices that occurred after the huge spike in oil prices in 2008. The spot price of oil dropped to about $31 per barrel briefly but this price is not sustainable in a world where the average cost of production is about $30 per barrel. If prices stayed that low for long, many of the higher cost of production facilities would close down for a while thus shrinking supply and sending the price of oil back up to at least fair value of $60 per barrel in short order. My hypothesis is that if I bought Exxon Mobil stock at about $55 per share assuming oil is trading at about $60 per barrel that I could reasonably expect to double my money in three years.

Variant View

Many things could happen to cause my speculation in Exxon Mobil to go terribly wrong. First, I believe that the world seems to be headed toward lower growth/recession in my opinion. If the world economy slows down significantly, the demand for oil could drop, thus potentially sending oil prices lower. Jim Chanos and Kyle Bass make excellent arguments as to why the economies of China, Europe and Japan are in serious trouble. I do not feel the need to cover these topics in this article. Do a Google search of "Jim Chanos China" and "Kyle Bass Japan" if you are unfamiliar with their views on these subjects.

Second, if tensions with Iran subside, the price of oil may go down to reflect the decrease in risk of supply disruptions. It is possible that Iran will take actions to satisfy the U.S. and Israel that its nuclear program is peaceful or at the very least that their program is a long way from having enough highly enriched Uranium to make a nuclear weapon.

Lastly, when I invest in an oil company I always worry that the company could have a major accident like the huge oil spill that (BP) had not long ago. The Deepwater Horizon spill in the Gulf of Mexico caused BP stock to drop about 50% in short order. I know that the risk is very small for a great company like Exxon Mobil, but it is nonetheless real and should always be considered before making an investment.

Source: Exxon Mobil: Speculative Buy At $55