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The analysts say that it is time to own those petroleum refining stocks that will maintain well under pressure if the industry gets worse.

A useful screening criteria to select those petroleum refining stocks that have the ability mentioned before is beta.

Note that in finance the beta (β) is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. You can think of beta as the tendency of a security's returns to respond to swings in the market.

  1. A beta of 1 indicates that the security's price will move with the market.
  2. A beta of less than 1 means that the security will be less volatile than the market.
  3. A beta of greater than 1 indicates that the security's price will be more volatile than the market.

It is therefore a matter to determine how the stock market usually perceives the risk of the petroleum refining industry and its stocks.

We were looking for studies that might have analyzed how the stock market perceive the risk of the petroleum refining industry and we found this study that undertook ''a comparative analysis of the stock market perception of risk of U.S. listed transportation sectors over the period July 1984 - June 1995.'' The authors have paid particular attention to water transportation industry, a sector often associated with high riskiness in comparison with other economic sectors. We will use the results of the petroleum refining industry in particular. ''

About 166 U.S. listed stocks from different transportation sectors (including 16 petroleum refining stocks) were observed over 11 years from July 1984 to June 1995. The market betas were positive and statistically significant for each company in each industry. Their values ranged from 0.689 (real estate industry) to 1.011 (rail transportation) for the whole 11 years period.

The average market beta of the petroleum refining industry was found to be 0.976, estimated with the multifactor model, which is one of the highest but it is lower when compared to the 1.011 for the rail transportation industry. See table below:

Table 1

So the petroleum refining industry was not the lowest volatile industry when compared with other transportation sectors but it was less volatile than the market.

The results of the market betas for the two sub-periods were also very significant: when the study switched from the first sub-period July 1984 - December 1989 to the second sub-period January 1990 - June 1995. The market betas tended to show an increasing trend over time, while the beta of the petroleum refining industry dropped significantly. In fact it dropped to 0.938 of the second sub-period January 1990 - June 1995 from 0.997 of the first sub-period July 1984 - December 1989.

Another important result that emerges from the study mentioned is that there is a "size effect" in the petroleum refining industry for the whole period and in particular higher returns are associated with big firms and lower returns are associated with small firms.

Knowing all of these things is very important because they are useful to make investment decisions involving the choice of the industries and stocks that will make the portfolio.

Another way to select the stocks that hold up best if an industry begins to turn bad is how the stock market perceives the risk of investing on petroleum refining stocks during market downswings.

Downswing may refer to the downward movement in the value of a security following a period of stable or rising prices. Investopedia explains that ''a downswing in the stock market or a single security will usually occur after the market has peaked.''

We compared monthly market returns (S&P500) with those of the petroleum refining stocks that compose the *Refin index in order to see how the stocks performed when S&P500 had downswings.

The period observed is January 2002 - January 2014. The monthly market and refiners returns are calculated as ln(Pt/Pt-1) + DYt. P refer to the monthly prices of S&P500 and refiner stocks. DY is the yield dividend. t are the months. Dividends paid over the year are allocated equally over the 12 months of the year. Information on S&P500 and stocks prices are taken from yahoo finance. A great Internet resource to search for dividend historic data on stocks and S&P500 is longrundata.com.

From the analysis we excluded those stocks for which information on prices and dividends doesn't cover the entire period observed and those that don't have at least 10 years of continuous dividends paid. We end up with 7 refiner stocks, which are Hess Corporation (NYSE:HES), HollyFrontier Corporation (NYSE:HFC), Imperial Oil Ltd. (NYSEMKT:IMO), Marathon Oil Corporation (NYSE:MRO), Murphy Oil Corporation (NYSE:MUR), Valero Energy Corporation (NYSE:VLO) and YPF S.A. (NYSE:YPF).

Below you can see a picture of how the Market performed in terms of returns over the full period:

Graphic 1

From the graph you can see the series of upswings and downswings during the entire period covered by our analysis.

We estimated the betas for each of the seven petroleum refining stocks over the full period and over each sub-period. Below are the test results of the way that the market has perceived the riskiness of the seven petroleum refining stocks over the entire period and over two sub-periods:

Table 2

Betas are computed as Cov(Stock Ret.,S&P500 Ret.)/Var(S&P500 Ret.), according to the CAPM. Monthly data on 4-weeks Treasury Bills (Risk Free Rate) are taken from the Federal Reserve Bank of St. Louis website.

HES, HFC, IMO and MUR have been less volatile than the market over the full period. IMO has been less volatile than the market over both sub-periods, instead HES, HFC and MUR have been less volatile in the first sub-period and more volatile than the market in the second sub-period even though HFC's beta is close to 1 in the second sub-period.

In contrast with the other stocks YPF has been less volatile in the second sub-period, but more volatile in the first one.

It is interesting to see how betas were in correspondence with the market's downswings. The picture below shows the sub-periods in which the market's downswings were more concentrated. When the monthly return on S&P 500 is negative then logical function available in the spreadsheet will give 1 as test result, otherwise 0. Each bar corresponds to a negative monthly return on the market:

Graphic 2

As you can see the bars are more concentrated during 4 sub-periods (each of them is composed of 12 months). The following are the four sub-periods:

  1. 2002:1 - 2002:12
  2. 2007:5 - 2008:4
  3. 2008:5 - 2009:4
  4. 2011:5 - 2012:4

Now we will see how betas performed during these 12 months 4 sub-periods:

Table 3

As you can see HFC and YPF were less volatile than the market 3 times out of 4. VLO has always been more volatile than the market. During the 4th period Ypf is the only petroleum refining stock that has been less volatile than the market.

These relevant market downturns are of course concentrated in the 2001 - 2003 period (early 2000s recession) and in the Q3-2008 - Q2-2009 period (The Great Recession).

Furthermore over the whole period observed (2002:1,...,2014:1), being 145 observations, we considered the times (months) that the return on refiner stock was higher than that on the S&P 500 (market) and the times (months) the return on the market was higher than that on the stock. Note that "higher" does not necessarily mean that a monthly return was positive, but it does mean that it was better (or less worse) than the other. We computed the difference between the two monthly returns (Rmkt - Rstock), we did the same thing for each row when return on market was higher than that one on the oil refiner stock and vice versa. In the end we calculated the average of the differences of the returns both in the case in which the return on the market was higher than the stock, and in the case where the return on the stock was higher than that on the market. The test results are summarized in the following table:

Table 4

For example over 145 observations monthly return on HFC was better than that on S&P 500 in 92 cases and worse in 53 cases. Over 92 cases the monthly return differences between HFC and market was 9.88% on average. Over 53 cases the monthly return differences between market and HFC was 6.79% on average.

Since we wanted to see how the stocks have performed in correspondence with the time intervals in which the market had downswings, for each month (row) in which the return on S&P 500 (the market) was negative we computed the difference between the two monthly returns (R.mkt - R.stock) when R.mkt > R.stock and when R.mkt < R.stock. To do this we have used the logical functions available in the spreadsheet of open office: =IF((Bt<0)AND((Bt<Ct)) ;Ct -Bt;0) and =IF((Bt<0)AND((Bt>Ct)) ;Bt-Ct;0) where t are the months (rows), C (column) is the monthly return on stock and B (column) is the monthly return on S&P 500. Then we calculated the average of the differences of the returns both in the case in which the return on the market is higher than the stock and in the case where the return on the stock is higher than that on the market. The test results are summarized in the following table:

Table 5

(click to enlarge)

For example over 53 observations (when monthly return on the market was negative), monthly return on HFC was better than that on S&P 500 in 35 cases and worse in 18 cases. Over 35 cases the monthly return differences between HFC and market was 5.68% on average. Over 18 cases the monthly return differences between market and HFC was 3.84% on average. HFC and YPF seem to have performed better than the market when the latter had downswings. It seems that HFC and YPF performed even better than the other five petroleum refining stocks during market downswings.

These results are in line with those of table 3, in fact, HFC and YPF have been less volatile than the market three sub-periods out of 4.

The results of table 5 say that VLO has performed poorly during market's downswings when compared to the others stocks. The results of table 5 confirm those of Table 3 where VLO has always been more volatile than the market.

Conclusion:

The analysis of volatility is crucial to make informed investment decisions involving the choice of the industries and the stocks that will make the portfolio.

We can use beta to screen those petroleum refining stocks that showed to be less volatile than the market and see how they usually performed during market downswings.

On the basis of this analysis we found that HFC and YPF have tenaciously resisted during the hard economic times. VLO was the weakest.

Furthermore one of these stocks, HFC, fits in with 9 out of 10 screening criteria of the defensive investor policy:

a) Excluding small companies = yes
b) Stocks with current assets at least twice their current liabilities = yes
c) Working capital (current assets - current liabilities) > long term debt = yes
d) Some earnings for the common stock in each of the past 10 years = yes
e) At least 10 years of continuous dividend payments record = yes
f) Earnings growth. 33% cumulative earnings growth over 10 years = yes
g) Current price is no more than 15 times average earnings over the past 3 years = yes
h) Price to book value ratio of no more than 1.5 = yes

i) P/E x P/B < 22.5 yes

l) no single year with ROE under 15% = not

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.

Source: Which Petroleum Refining Stocks To Get Defensive On