The Importance of Stock Picking, Illustrated in Oil

If a commodity is hot, stocks of companies that deal in that commodity should be hot as well, right? Well, not necessarily so. To be sure, energy shares have outperformed the stock market indexes during the recent period of oil price strength. Take a look at relative performance of two energy shares, Exxon and Valero Energy (XOM, top chart; VLO, second chart) vs. oil itself (DBO). From these charts (kudos to the MSN Money site), it's clear that the stocks have greatly underperformed the commodity.(Click charts to enlarge.)

In the two money flow charts below (XOM, first chart below; VLO, bottom chart), you can see the reason for this: as a whole, funds have been flowing out of these issues over the past six months. Forays above the neutral, blue line (the point separating five-day inflows from outflows) have been relatively brief and contained.

With oil making fresh price highs over the past two weeks, one would expect these stocks to be making new peaks as well. XOM, however, has moved from 92.45 to 88.82 in that time, with only one day out of the last ten displaying positive money flows. VLO has seen a particular sharp outflow over this period (as the money flow chart above displays), and the stock has moved from 52.93 to 44.56. Only three in the last ten sessions have shown positive money flows for VLO.

The moral of the story is twofold:

1) Assuming a stock will be strong just because a related commodity is strong is surface reasoning that can get you in trouble. Oil prices might be strong, but it doesn't mean that particular oil companies are drilling or refining more of it.

2) Money flows matter. Regardless of the attractiveness of the story, if investors are taking money out of a stock over time, it is going to be difficult for that issue to perform strongly.

I notice that Halliburton (HAL) and XTO Energy (XTO) have seen net inflows to their shares for five of the past ten trading sessions; both of those energy issues are higher over the last ten days, unlike XOM and VLO. Stock picking matters, and the flows of funds in and out of shares and sectors is one important factor in determining relative stock performance.

Comments

[AndyS]

I hope XTO benefits from the inflow and rising NG prices.

[BrianPursley]

"40 percent of a stocks price movement is due to the market, 30 percent to the sector, and only 30 percent to the stock itself which is something I believe is true. I don't know if the percentages are exactly correct, but cenceptually the idea makes sense." -- Stevie Cohen

[Dave, WV]

I think Valero has recently been beaten down because they are a refiner, and the price of refined products has not risen with crude in recent months (it has risen, but more slowly). Last year this time, oil was $70, and wholesale gasoline was in the mid $2-s, and VLO traded in the 60s. I don't believe the refiner's tight margins will hold thru the summer. I expect VLO to climb significantly in the coming months.

[bearfund]

Over the past 3 months, STO has outperformed not only XOM and VLO but even USO itself. On a 6-month basis, it's up 20%, better than all but XTO though only half as much as USO in that time. However, unlike tax-nasty USO and penny-pinching XTO, it pays a fat tax-friendly dividend in a few weeks. Still, if you want to talk about the importance of stock picking, a comparison with XLE seems in order. On a 3- and 6-month basis, XTO and STO are well ahead of XLE; XOM and VLO are far behind.

[Wez]

You do know that VLO is not an "oil" stock, right? It's a gasoline and retailer (gas stations). When the price of oil goes up more than the price of gas, VLO loses. You are comparing apples to oranges. You are making the argument that stock picking matters by comparing two very different companies. If you were to compare two stocks that are positively correlated to the price of oil, you would have more ground to stand on.

[CrossProfit]

Wez,

Exactly the author's point!

"...just because a related commodity is strong ..." - author uses the term "a related commodity". Author is saying that you have to further dissect sectors in order to pick the winners etc.

This is clear to me...not meant to say that VLO and XOM are the same, the contrary - author is saying they are NOT the same apples.

Saul Sterman
CrossProfit

[pockyclips2020]

Wez has hit the nail on the head. Those who own and produce the oil vs those who refine and distribute are the ones benefiting from the run-up in crude. Same goes for nat gas producers.

[KSTHANE]

I agree with wez. The general message to do more research makes sense, but the examples don't. Toys are made from plastic which is made with oil so are toys a related product? Valero and Exxon are about as different as Hasbro and Exxon considering the former in each case are just resellers of a reformulated (though obviously, Hasbro moreso) commodity.

[gandalf thewise]

there are no "percentages"... to break down to determine a stock price.

there are only the number of premiums, discounts, and how much accelerating momentum in those premiums, long term, each stock has.

[Wez]

CrossProfit - Agreed, but the author seems to be making a case for picking stocks instead of just buying a sector fund or an ETF. If thats not the case, than what is the point of the article, because the examples he gave are like comparing Exxon to Hasbro.

[CrossProfit]

KSTHANE, pockyclips2020 and wez,

Don't ask me why I'm doing this because I don't know why myself.

First, read the article again.
Second, the author is giving two negative examples from the energy sector; XOM and VLO. Both underperformed the commodity that they are associated with.

Third, the author explains that even though XOM is a oil E&P stock, because it produced less last quarter (coupled with tighter upstream margins - not mentioned in article) there was outflow. This is the #1 in "The moral of the story". The #2 is related to VLO, a refiner.

Fourth, the author then gives two positive examples ***in relation to cash flow*** using HAL and XTO. HAL and XTO are intentionally used to demonstrate the point. Just because they are in the same sector it doesn't necessarily mean that they have anything in common other than the cash flow issue. The author is intentionally using pairs that don't match up!

The author is saying one thing only ***follow the cash flow***. NOT that HAL and XTO are the same apples or that XOM and VLO are the same oranges. The four are classified in the 'energy sector' - that is all that they share in common. (XTO and XOM are both E&P as well yet the former is used in a positive example and the latter in the negative example).

I trust this is clear now.

Saul Sterman
CrossProfit

[Wez]

Does anybody really need to be told that some stocks in an industry/sector will under perform? I agree with what you are saying CrossProfit, I just don't get the article, as it was titled. When the title of an article is "The importance of Stock Picking", it implies that actively picking individual issues is somehow better than buying ETFs, indexing, whatever. Since most readers of Seeking Alpha are already convinced of the importance of picking stocks, who is this article trying to educate?

[CrossProfit]

wez,

Just noticed your latest post after I posted my previous reply.

First, I agree that the author is insinuating that a sector ETF is not the way to go.

Second, I disagree with the author's premise that short term flows can be used for medium term investing, especially right after earnings.

Third, the author did NOT post the size (volume) of the flows which is crucial for any meaningful analysis.

Fourth, the author has not indicated if a specific fund is behind the sell off or accumulation.

Fifth, the author did NOT specify if there were any recent upgrades or downgrades, the reasons why and by whom.

Sixth, the author is making one point only - follow the money. This is usually good for short term plays, at best. It could reverse next month etc.

Saul Sterman
CrossProfit

[blanco-dee]

To take it one step further, despite the fact that refiners are doing so poorly, in times of extensive over-speculation on oil exploration and production companies, and oil sector ETFs, the refiners make sense as a hedge.

buy low, sell high - selling oil stocks higher was last weeks play,

good luck to the posters, with GW talking to the Saudis this week I expect some excitement over E&P companies this week and next - hold on to your hats!

[CrossProfit]

blanco_dee,

I agree that some refiners are beginning to look like an attractive hedge.

No comment about the rest of your comment.

Saul

[fatcat]

you dumb bastards,Karn Finnerman said she was long calls on vlo on friday,that was 75% of the move..

[mwswi]

fatcat,

I'm guessing you're just being factitious. If so, that's a pretty good imitation of the typical MarketWatch community commentary.

stanton

[dangertiger]

CrossProfit,
What I think most of the other people in this article are trying to say is that we already know that oil and gasoline retailers are not correlated. The author thinks we all need to be told this.

HOWEVER, he makes a good point by saying that we shouldn't just buy XOM because it is related to an appreciating commodity. Hopefully an obvious point when it comes to picking stocks but helpful advice never hurt anybody.

Simple as that.

[cvillelb]

Speaking of ETF's ,does anyone know of an ETF of refiners only?

[fatcat]

Sorry that came out wrong out of frustration.My point was to be that there are many more non-fundamentals effecting these things.

[investorslive]

XTO should benefit from the inflow and rising NG prices.

www.investorslive.com/...

[User 192279]

asd

[User 192279]

Hm .. Don't know what to say to that. VLO is a refiner and is not exposed to oil price, other than suffering when it goes up sharply and does not pass through to consumers, and benefiting a little from the volume gain it creates in its catalytic crackers. So you completely missed on that one. VLO tracks 321 crack, not oil price.

XOM is an integrated and it is exposed to oil price, although it is well diversified in refining and retail and these businesses actually moderate the oil price impact on its stock. If you wanted to truly test that relationship, you need to look at independent producers pure play companies like Anadarko, Hess, Encana to name a few.

You do need to know the subject before you begin publishing articles.

[Arch]

What about drillers like DO and RIG? i like DO. Refiners pay the high price for crude, the reason why a lot of them have lost since mid 2007.

On other note, as I understand it, the author seems to be making a point to follow the market, by following the cash flow. Buy what others are buying and sell when others sell. I think, retail investors will almost always find themselves buying at the peak and selling at the bottom if they follow this rule.

[ninety seven]

User 192279 states that you need to know the subject before publishing articles.

For his enlightenment, cat cracking does not result in volumetric expansion, hydrocracking does.

Hess is not a pure play company. It has both upstream and downstream aspects to its business.

Refining moderates the effect of high crude prices on XOM's business if by moderates he means that it lowers the bottom line. XOM produces 40% of crude but then goes to the marketplace for the other 60%. There were a few recent good years in refining for XOM but that has not been the rule and certainly is not now.

[User 195367]

Oil is Valero's raw material cost so the stock should drop as oil rises. The stock is behaving just like I would expect it to.

Exxon has stagnant or dropping oil production and is content to buy back its own stock which provides little or no gain to investors despite what some erroneously believe.