Undervalued Indicators For Big Oil

Includes: PSX, VLO
by: Shaun Forney

Warren Buffett used a series of evaluative metrics when searching through thousands of pages of books and financials for the perfect stock before the rise of the internet. Why not follow the guidelines of one of the richest men in the world? Having billions of dollars can't be too bad. One of his metrics is looking at the P/E ratio vs the price to book ratio and if these metrics happen to be lower than 22.5 Buffett would take a further look at the company because this is in an indication that the company could be undervalued. Looking at the oil industry a majority of the stocks are undervalued.

Evaluation Formulas

Stock Trailing P/E Forward P/E Price/Book Tp/e*p/bv Fp/e*p/bv
XOM 9.15 10.81 2.39 21.87 25.84
PSX 9.35 8.52 1.78 16.64 15.17
PBR 11.09 7.34 0.65 7.21 4.77
VLO 10.84 6.95 1.22 13.22 8.48
SLB 17.59 12.53 2.65 46.61 33.20
BP 11.45 8.07 1.11 12.71 8.96

Buffett also notes that the P/E should be 15 or lower and Price/Book should be lower than 1.5. Looking at the table above using Buffett's quick evaluation formula several oil companies are severely undervalued. The decline in value between the Trailing P/E and the Forward P/E is something to consider in your analysis but since the market is almost omniscient these factors are already built into the stock price. British Petroleum (NYSE:BP), Valero (NYSE:VLO), Petrobras (NYSE:PBR), and Phillips 66 (NYSE:PSX) are well within Buffett's margin for evaluation below the 22.5.

There is uncertainty around BP dealing with the pending litigation regarding their spill in the Gulf of Mexico. PBR is also dealing with uncertainty in the future production and unsustainable rising debt which has increased three fold since 2008 and will affect purchasing power in the future.

PSX experienced a sharp pullback on 4/1 as the oil industry as a whole experienced a decline. The stock is well valued and remains oversold from the pullback on 4/1 with an RSI at 31.50. From a technical perspective the 20 day EMA is closing in on the 50 EMA indicating the stock might be ready to rally. Volume remains average though and with a beta of 2.18 the stock will be influenced by what the market has in store even though the company's fundamentals are solid.

VLO experienced a pullback on 4/1 similar to PSX. The stock recently reached it's one month low on April 16th. Since then it has posted positive gains. VLO recently became neutral with an RSI of 39.2 since it was oversold on April 16th. It seems to be reversing it's losing trend with 3 days of consecutive gains even though 20 day EMA just crossed below the 50 day indicating a sell signal.

PSX and VLO both have a great dividends and according to Buffett's simple evaluation metric are terrific buying opportunities. The advantage of VLO is that options are written on a weekly basis and with the high volatility of the market today you may want to limit your exposure. So if you can buy low enough on Wednesday you could write a covered option for Friday close of business and close your position with the stock on Friday which limits your exposure.

Note: All data provided by Yahoo Finance on 4/23.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.