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A prior article highlighted the major integrated oil & gas industry as a promising investment opportunity based on its potential for generating alpha by stock picking. Attractively-priced stocks and perplexingly precious stocks were identified in the industry for constructing net-long positions. Such positions can capitalize on low valuations among big oil in Europe while protecting against a global recession.

Why consider hedged positions?

Alpha hunters might consider net-long positions in industries trading at attractive prices, market neutral positions for fairly valued industries, and net-short positions in industries with substantially unattractive valuations. If they are willing to hedge their positions, they can find more investment opportunities than just hoping to find the best stocks to buy today. Instead, they can use fully or partially hedged positions to bet on the mean reversion of different stocks in an industry while minimizing or reducing exposure to market volatility.

Plots of major integrated oil & gas companies reveal how some of these stocks are more attractively priced than others:

(click to enlarge)ROE vs. PB

(click to enlarge)Sales Growth vs. PS

(click to enlarge)Earnings Growth vs. PE

In each of these graphs a measure of quality or growth is plotted on the y-axis as a function of a measure of cheapness on the x-axis. Historical price-to-earnings multiples, price-to-book multiples, and price-to-sales multiples were used as measures of cheapness. Analyst estimates for earnings growth, historical return on equity, and historical sales growth were plotted as measures of growth or quality. More attractive stocks are found up and to the left while less attractive stocks are found down and to the right.

Three above-trend European stocks are presented in bold and two below-trend American stocks are listed in red:

Ticker

Company

Country

P/E

P/S

P/B

Growth Est

Sales Growth

ROE

BP

BP

United Kingdom

7.8

0.4

1.2

4.8%

7.1%

15.7%

COP

ConocoPhillips

USA

10.9

1.1

1.5

-2.0%

5.9%

11.7%

CVX

Chevron

USA

8.5

0.9

1.7

1.6%

3.8%

21.7%

E

Eni

Italy

9.5

0.5

1.1

7.2%

4.9%

12.4%

EC

Ecopetrol

Colombia

14.0

3.1

4.0

17.6%

26.4%

0.0%

OXY

Occidental Petroleum

USA

11.1

2.9

1.8

10.9%

6.4%

16.9%

SSL

Sasol

South Africa

8.9

1.6

2.2

6.3%

11.6%

24.1%

STO

Statoil

Norway

6.0

0.6

1.6

3.5%

5.2%

28.7%

TOT

Total

France

8.4

0.5

1.3

7.1%

4.7%

16.3%

XOM

Exxon Mobil

USA

9.4

0.8

2.5

7.5%

5.2%

28.3%

Data from finviz.com

BP, STO, and TOT were found to lie among stocks in the upper left of these plots (higher quality, undervalued stocks) while COP and OXY were found to lie at the lower right of these plots (lower quality, overvalued stocks). Based on this work, a net-long position in major and integrated oil companies can be constructed by buying BP, STO, and TOT shares while hedging with a smaller short position on COP and OXY. The resulting position exploits cheaper valuations in Europe while partially protecting against weak demand in the event of a global recession.

Please read the article disclaimer.

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.