Valuation Dashboard: Energy And Materials - Update

| About: Energy Select (XLE)

Summary

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

A valuation status relative to history.

A reference for picking stocks in each industry.

This monthly series of articles provides a valuation dashboard in sectors and industries. I follow up on 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 are calculated: Price/Earnings (P/E), Price to sales (P/S), Price to free cash flow (P/FCF), Return on Equity (ROE). 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.
  • They are compared with their own historical averages. The difference is measured in percentage for valuation ratios and in absolute for ROE. For valuation factors, it can be interpreted as a percentage in under-pricing relative to a historical baseline. It points to over-pricing when negative. In all cases, including ROE, the higher the better.

Industry valuation table on 2/14/2016

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. 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

15.72

24.2

35.04%

0.6

1.73

65.32%

11.33

35.34

67.94%

-10.09

7.34

-17.43

Oil/Gas/Fuel

13.5

18.53

27.15%

1.5

3.35

55.22%

14.96

29.03

48.47%

-14.34

4.47

-18.81

Chemicals

17.03

18.48

7.85%

1.24

1.21

-2.48%

27.92

25.37

-10.05%

8.39

6.74

1.65

Construction Materials

40.49

21.44

-88.85%

1.2

1.16

-3.45%

35.93

40.5

11.28%

9.28

5.77

3.51

Packaging

19.7

17.96

-9.69%

0.81

0.61

-32.79%

22.36

20.09

-11.30%

19.38

8.34

11.04

Metals&Mining

18.69

19.83

5.75%

1.42

2.65

46.42%

14.21

25.53

44.34%

-19.71

-8.6

-11.11

Paper&Wood

24.56

21.27

-15.47%

0.6

0.72

16.67%

36.15

22.81

-58.48%

7.38

4.99

2.39

The following charts give an idea of the current valuation status of Energy and Materials industries relative to their historical average. Higher is 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 has underperformed SPY by about 10%. XLB ends the period very close to the benchmark. In this correction, the five more resilient S&P 500 stocks in Energy and Materials on a 3-month period are Airgas Inc (ARG), Avery Dennison Corp (NYSE:AVY), Newmont Mining Corp (NYSE:NEM), Spectra Energy Corp (NYSE:SE) and Exxon Mobil Corp (NYSE:XOM). ARG price action is linked to an acquisition. AVY is 4% below an all-time high.

Chemicals and Construction Materials have significantly improved since last month in P/FCF, whereas Energy Equipment has deteriorated on the same factor. Paper&Wood sends contradictory signals, with a large improvement in P/E and a sharp deterioration in P/FCF. Metals/Mining has deteriorated in the 3 valuation factors. Packaging has improved in ROE for little variation in valuation. Other changes are less significant.

Chemicals look fairly priced, with all factors close to their baselines. Packaging is far above its average in quality, which may justify part of the overpricing. Energy and Metals/Mining as a group still look like value traps, apparently underpriced but with a ROE in negative territory and far below historical averages.

Comparing individual fundamental factors to the industry factors provided in the table may help find quality stocks at a reasonable price in any industry. 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.

EMN

Eastman Chemical Co

IOSP

Innospec Inc

KS

KapStone Paper & Packaging Corp

LYB

LyondellBasell Industries NV

POL

PolyOne Corp

REX

Rex American Resources Corp

TSO

Tesoro Corp

VLO

Valero Energy Corp

WNR

Western Refining Inc

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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.

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