In spite of the strong recent performance, the valuations of many energy stocks remain extremely cheap, suggests Ian Wyatt, growth and income expert and editor of Million Dollar Portfolio.

Specifically, the price-to-earnings multiple for the sector is still deeply discounted compared with the overall S&P 500 index. Actual earnings results have been increasing at a rapid clip. Cash flows are rising dramatically. Yet the latest rally in shares has only partially priced that in, creating the opportunity today.

Initially, I viewed the rise in oil and gas prices as a temporary reaction to the Russia and Ukraine conflict. However, further research leads me to believe that the market has been much tighter than previously thought.

We appear to be in the early stages of a multi-year period of higher energy prices while the world transitions to “green energy.” It appears that higher oil and gas prices will remain persistent.

Therefore, profits for stocks in the sector could remain inflated for several years. CEOs at most energy stocks are not investing in the development of new oil and gas wells as they have in the past. Instead, they’re returning cash to shareholders with higher dividends and stock buybacks.

Additionally, I don’t expect a speedy resolution to the conflict between Russia and Ukraine. Even if the conflict is resolved — it’s unlikely that Russia’s oil will immediately be flowing around the world. Additionally, China is finally easing some of their strict Covid restrictions. This should increase demand for oil in the coming months. Finally, high demand this summer and production limitations could send prices higher.

For these reasons, it’s possible that we see oil continue to move above the $130-$140 level in the coming months. I’m going to cautiously begin adding shares of several energy stocks to the Million Dollar Portfolio. These stocks will help diversify the portfolio with additional value and income producing investments — at a time when growth stocks and speculative stocks remain under pressure.

Shell (SHEL)

Shell is a United Kingdom-based energy company with worldwide operations. The company is one of the oil majors — valued at $227 billion. Shell operates the largest liquefied natural gas business in the world. And it also has the largest number of gas stations.

Like all oil stocks – Shell has performed well in 2022. Yet the stock is still among the cheapest energy stocks. Shares trade with a P/E of just 6.5 — versus Exxon Mobil (XOM) at 10-times earnings. The stock pays a 3% dividend yield.

Equinor (EQNR)

Equinor is a Norwegian producer of natural gas. The company is the 2nd largest producer in Europe. European natural gas prices are approximately 10-times greater than in the U.S. And this creates a profit windfall for this major producer.

Shares are trading at around $38. Meanwhile, the company’s earnings are expected to be $6.81 per share this year. That means the stock is dirt cheap — trading at under 6-times earnings. Earnings are being revised upward — yet the stock is flat in the last month. The company pays a 2% dividend, and plans to buy back $5 billion of shares with its excess cash flows this year.

DCP Midstream (DCP)

DCP is a master limited partnership (MLP). They operate midstream oil and gas services including transportation, storage and pipelines in the U.S.

Essentially, the company acts as a toll road for the oil and gas industry. That means they benefit from the overall growth in production, and have the ability to charge more when oil and gas prices are high.

Revenues are expected to jump 56% this year — and earnings will more than double. Shares are attractively priced at just 10-times earnings. The stock also offers a 4% dividend yield.

Exxon Mobil (XOM)

Exxon is one of the best-operated major oil companies and is considered a bellwether of the industry. You might expect to pay a premium for the stock. However, it also trades at a deep discount to the overall market.

Exxon revenues are expected to jump 47% this year — and earnings could double. Analysts have been aggressively raising estimates for the company. 90 days ago, the consensus was $7.40 EPS in 2022. Today the estimate is at $10.22 – and it could continue rising.

Shares are trading near a high. Yet the P/E multiple remains reasonable at just 10. Sales and earnings are expected to dip 10% next year, assuming that oil and gas prices drop. Even so — the stock looks cheap.

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