Stack up on Energy

04/09/2004 12:00 am EST

Focus:

James Stack

President, Stack Financial Management

InvesTech Market Analyst, long one of the best newsletters around, has added some new features to its issues, including sections focused on strategy, sector, and security analysis. In his first such feature, editor Jim Stack focuses on energy and his favored play in this area 

"We believe there is excellent profit potential in the energy sector. With this in mind, we recently added Vanguard Energy to our stock portfolio, taking our energy sector allocation to 18% of the portfolio–more than double that of the S&P 500, and our largest portfolio weighting. Vanguard Energy Fund (VGENX) is our favored mutual fund choice in the energy sector. Our bullish view is based on the supply and demand dynamics that Wall Street seems unwilling to accept. Strong commodity prices in the sector are backed by a strengthening economy and continuing unrest in the Middle East and Venezuela. The synchronized worldwide economic recovery and soaring demand from China, coincident with a constrained supply picture, should keep product prices from dropping significantly from today’s high levels.

"Our attraction to this fund rests primarily in its low-risk profile and valuation-based investment philosophy. The fund’s focus on large integrated oil firms goes a long way in explaining its relative low-risk profile. Because of the integrated operations of these mammoth entities, they have less exposure to the fluctuations in oil and gas prices than narrowly focused exploration or energy service firms. Also, the large integrated firms often pay substantial dividends, which have historically provided greater share price stability than those companies that pay little in the way of dividends. In addition, the portfolio has avoided mining issues and invested a substantial portion of the assets in foreign domiciled energy firms, which also reduces volatility. Our analysis shows current share prices on diversified, good-quality energy companies are in many instances 20%-50% below our estimations of their intrinsic values.

"We are impressed with the fund managers’ attention to valuation. Its valuation metrics such as p/e and price-to-book ratios, are lower than those of other energy sector funds. S imilar to most Vanguard offerings, the Energy Fund has a low-cost structure and an experienced management team. Its expense ratio was 0.4%, vs. 1.73% for the average specialty natural resource fund. The three-person management team has an average tenure of almost eight years vs. 4.6 years for the category average. Of course, all of these positive attributes would be meaningless if the long-term performance record was not superior to the category average. Based on 12/31/03 data, the fund’s one-, three-, and five-year performance figures far surpassed the results of the S&P Energy Sector Indexes for similar time periods. Its performance against other specialty-natural resource funds has also been exceptionally good, ranking in the top 30% of the category for the last three- and five-year periods."

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