Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks. - Warren Buffett, CEO of Berkshire Hathaway, born Aug. 30, 1930
Since taking over in 1965, Warren Buffett has grown Berkshire Hathaway's book value at a compound annual rate of more than 20% -- double the market's return. Just $10,000 invested in Berkshire Hathaway as late as 1980 is worth nearly $3 million today. - Matthew Argersinger
These two quotes are not intended to make anyone feel regrets, nor to encourage the purchase of Berkshire Hathaway A (BRK.A) or B (BRK.B) shares.
For those who have never done so, I would encourage any investor to study the Berkshire Hathaway website and ask yourself, "Why wouldn't anyone want to own some B shares at $78 or less?"
How did Mr. Buffett and his shareholders do so well over time? By buying profitable, well-capitalized businesses that were not being fairly priced by widely respected valuation metrics. Mr. Buffett and his assistants looked for "distress sales" or situations where the current business model of the company was misunderstood.
In short, they continue to find opportunity amid the "rubble" of an industry or sector that has been "trashed." That may be why Mr. Buffett is rumored to again be looking for bargains in Europe right now.
Yes, dear reader, that brings us to the topic mentioned in the title of this article:
What Is Perhaps The Second Most Undervalued Sector Currently?
There are a number of different metrics we used, but we like the ones that Buffett students tend to choose and are likely to meet his criteria. Those include a return-on-equity greater than 15%, a price-to-book ratio of less than 1.5, and a forward price-to-earnings ratio of less than 20.
There's a short Bloomberg video on this topic that most adherents to Buffett-style investing will find both educational and entertaining.
A true "undervalued" stock and sector should include smartly run companies that don't have much debt (a debt/equity ratio of 1 or less). The sector that has a nice list of these kinds of companies is the energy sector, and several of them are currently overlooked and "on sale."
Here's a six-month chart of the ETF Energy Select Sector Spider (XLE). You can see it's had a meaningful correction.
I've included the 200-day moving average and the Bollinger Bands. The current price level is slightly above the lower Bollinger Band.
Tops on my list would be ConocoPhillips (COP). With its recent spinoff decision, this 3.5% dividend yielding energy superstar looks better than ever, especially with the price down below $74.
Another energy stock that look very undervalued is Apache (APA), the independent energy company selling with a forward P/E ratio of 7. Apache has consistently paid down debt, a shining quarterly earnings growth (year over year) of almost 73%, and $2.3 billion in levered free cash flow.
The Bloomberg video also mentioned HollyFrontier (HFC), an independent petroleum refiner and marketer in the U.S. With a current P/E ratio of less than 5 and a forward P/E of 7.5, this company and its story is worth taking a close look at.
Looking at the key financial statistics allows us to see how inexpensive the stock price of HollyFrontier really is. Let's start with a return on equity of 30%. Then consider the PEG ratio (five-year expected), which stands at 0.18. This is the P/E ratio (4.68) divided by the annual earnings-per-share growth.
HollyFrontier astounded Wall Street with its quarterly earnings growth (year over year) of 1,418% and quarterly revenue growth of 125%. No wonder the PEG ratio is so low.
As we look at the six-month chart, we see an appealing scenario.
HollyFrontier is close to the lower range of the Bollinger Bands, and it penetrated its 200-day moving average of around $31 on Thursday, April 12.
Like the entire energy sector, HollyFrontier is flirting with a upside breakout. On May 7, the company will announce its first quarter 2012 earnings. With its current 11.39% operating margin, don't be surprised to see HollyFrontier meet or exceed expectations.
Oil prices seem stuck at $100 per barrel or even higher -- especially if a sudden outbreak of war or interruption in supplies occurs. At some point, natural gas will bottom and start heading higher. The Buffett-priced, undervalued and misunderstood companies will rocket.
These include Devon Energy (DVN), which is dedicated to making itself more of an oil producer and less focused on natural gas. Devon plans to invest billions of dollars over the next 10 years on a number of oil sands projects in Canada.
Recently, Devon's leadership stated that the company hopes to quadruple oil production by 2020. As of Dec. 31, 2011, the company had proved undeveloped reserves of 782 million barrel of oil equivalent. But that's not all. If you've noticed companies like Cheniere Energy (LNG) hitting 52-week highs, you know how "on fire" the Liquid Natural Gas market is.
Few realize that Devon provides marketing and midstream services for selling natural gas liquids that are extracted from the gas streams processed by its plants. This will become more and more profitable as the demand for liquid natural gas skyrockets, and the earnings will drop right to Devon's bottom line.
Devon's price, as the six-month chart demonstrates, has hit that "sweet spot" just above the 200-day moving average and the bottom of the Bollinger Bands range.
Now's the time to watch these energy companies attentively. The fact that they're quite undervalued won't be forgotten too much longer.
