Valuation Dashboard: Energy And Materials - Update

Summary

4 key fundamental factors are reported across industries in Energy and Basic Materials.

They give valuation status relative to history.

They give a reference for picking stocks in each industry.

This monthly series of articles provides a valuation dashboard in sectors and industries. I follow up a certain number of fundamental factors and compare them to historical averages. This article covers Energy and Basic Materials. The choice of the fundamental ratios used in this study has been justified here and here. You can find in this article numbers that may be useful in a top-down approach. There is no analysis of individual stocks. A list of stocks to consider is provided in the conclusion.

Methodology

• Four industry factors calculated by portfolio123 are extracted from the database: Price/Earnings (P/E), Price to sales (P/S), Price to free cash flow (P/FCF), Return on Equity (ROE).
• They are compared with their own historical averages "Avg". The difference is measured in percentage for valuation ratios and in absolute for ROE, and named "D-xxx" if xxx is the factor's name. For example, D-P/E = (AvgP/E - P/E)/AvgP/E. It can be interpreted as a percentage in under-pricing relative to a historical baseline: the higher, the better. It points to over-pricing when negative. ROE is already a percentage. That's why we take the simple difference: D-ROE = ROE - AvgROE.

The industry factors are proprietary data from the platform. The calculation aims at eliminating extreme values and limiting the influence of the largest companies. These factors are not representative of capital-weighted indices. They are useful as reference values for picking stocks in an industry, not for ETF investors.

Industry valuation table on 1/24/2016

The next table reports the 4 industry factors. For each factor, the next "Avg" column gives its average between January 1999 and October 2015, taken as an arbitrary reference of fair valuation. The next "D-xxx" column is the difference between the historical average and the current value, in percentage. So there are 3 columns relative to P/E, and also 3 for each ratio.

 P/E Avg D- P/E P/S Avg D- P/S P/FCF Avg D- P/FCF ROE Avg D-ROE Energy Equipment&Services 16.43 24.2 32.11% 0.58 1.73 66.47% 7.29 35.34 79.37% -9.37 7.34 -16.71 Oil/Gas/Fuel 13.23 18.53 28.60% 1.4 3.35 58.21% 14.59 29.03 49.74% -14.51 4.47 -18.98 Chemicals 16.98 18.48 8.12% 1.18 1.21 2.48% 31.77 25.37 -25.23% 8.93 6.74 2.19 Construction Materials 42.52 21.44 -98.32% 1.25 1.16 -7.76% 51.94 40.5 -28.25% 9.34 5.77 3.57 Packaging 18.65 17.96 -3.84% 0.83 0.61 -36.07% 22.79 20.09 -13.44% 17.77 8.34 9.43 Metals&Mining 16.48 19.83 16.89% 1.21 2.65 54.34% 11.71 25.53 54.13% -19.89 -8.6 -11.29 Paper&Wood 30.31 21.27 -42.50% 0.69 0.72 4.17% 20.72 22.81 9.16% 7.74 4.99 2.75

The following charts give an idea of the current valuation status of Energy and Materials industries relative to their historical average. In all cases, the higher the better.

Price/Earnings:

Price/Sales:

Price/Free Cash Flow:

Quality (ROE)

Relative Momentum

The next chart compares the price action of the SPDR Select Sector ETF in Materials (NYSEARCA:XLB) and energy (NYSEARCA:XLE) with SPY (chart from freestockcharts.com).

Conclusion

In the last 3 months XLE and XLB have underperformed SPY by respectively -11% and -6%, driven by WTI oil price falling below \$30. In this meltdown, the five more resilient S&P 500 stocks in Energy and Materials on a 3-month period are Airgas Inc (NYSE:ARG), Ball Corp (NYSE:BLL), Monsanto Co (NYSE:MON), Sherwin-Williams Co (NYSE:SHW), Valero Energy Corp (NYSE:VLO). ARG hit a new all-time high in January, with a gain over 60% since the announcement in November of an acquisition by Air Liquide (ADR: OTCPK:AIQUY).

Valuation ratios have significantly improved for all industries because of price action, except P/E for Paper and Wood and P/S for Metals and Mining, which are stable. As a group, energy and metal/mining are still looking like value traps: valuation ratios show an apparent underpricing, whereas the quality factor (ROE) is much worse than the historical average. This is not true for all the oil industry: refiners are doing quite well.

No industry in these two sectors looks very attractive. However, comparing individual fundamental factors to the industry factors provided in the table may help find quality stocks at a reasonable price. The next table shows a list of stocks in the Energy and Materials sectors. They are all cheaper than their respective industry for the 3 valuation factors simultaneously: Price/Earnings, Price/Sales, Price/Free Cash Flow. Then they are selected for their higher Return on Equity.

This screen updated and rebalanced monthly has an annualized return about 17% for a 17-year backtest. The corresponding sector ETFs XLE and XLB have an annualized return of respectively 8.32% and 6.79% on the same period. Past performance, real or simulated, is not a guarantee of future return. This list may be considered an entry point for further due diligence, or as a portfolio after adding trading rules and market timing. This is not investment advice. Do your own research before buying.

 ATW Atwood Oceanics Inc. ENERGYEQUIP DOW Dow Chemical Co (The) CHEM EMN Eastman Chemical Co CHEM IOSP Innospec Inc CHEM LYB LyondellBasell Industries NV CHEM MTX Minerals Technologies Inc. CHEM REX Rex American Resources Corp OILGASFUEL TSO Tesoro Corp OILGASFUEL VLO Valero Energy Corp OILGASFUEL WNR Western Refining Inc OILGASFUEL

The oil, gas and fuel companies in the list are 3 refiners and a producer of bio-ethanol. They are less dependent on crude oil price than the rest of the industry.

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Disclosure: I/we 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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.