We get asked this question. A lot. Investors, scorched by multiple expansion in speculative stocks, are understandably concerned about the movement of prices in oil and gas.  We believe the reason to invest in oil stocks stems from a fundamental backdrop for the sector, unlike anything we have seen in our careers.

We are going to generalize. No offense intended.  We see three primary groups of equity investors today:

  1. Index Fund Investors: since we first wrote up energy over 18 months ago, the sector’s weight in the S&P 500 has doubled to 4.8%, so this group has “decided” to put less than a nickel of every dollar into some of the cheapest, most well-run and disciplined group of capital allocators in the market (we thank them for making what we believe is a catastrophic error)
  2. Active Managers: hewing to explicit or implicit environmental mandates that have deemed the producers of energy to be “bad” – this is a very large group of a shrinking pool of active managers who are willfully omitting energy and embracing “Clean Tech” stocks that often lack fundamental merit
  3. Active Managers who deviate from what we believe are flawed index funds and seek out firms with robust fundamentals that are often shunned by the crowds. These investors favor assets that provide a significant margin of safety based on a view that “risk” is defined as the permanent impairment of capital.

Fortunately, that third group has never been smaller from what we can tell.   The capital discipline, commitment to healthy balance sheets, and exploding free cash flow that characterizes oil and gas stocks seem to count for little.  This indexing age has created market inefficiencies so large and so slow to resolve themselves that it is almost hard to believe.

Figure 1 suggests this is the early innings for energy. Oversimplified? Yes. Compelling? Yes. Complicated? No.

Energy Stocks Are Still At Record Cheapness vs Information Technology

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When to Buy Oil Stocks

Nobody at KCR relishes the pain high energy prices are inflicting on the world.  And we certainly do not write this piece with any illusions that things cannot go wrong for oil and energy stocks. Here are some examples:

  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.
The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra reading for anyone seeking out more information related to the topics above.

[i] Note: if you are wondering why we chose natural gas over oil please let us know.  We believe the US natural gas situation is unique.  Natural gas is cleaner per BTU compared to other hydrocarbons, benefits from increasing LNG capacity which may create tailwinds for US gas which is at record discounts to overseas markets and is a critical input for manufacturing fertilizer which is in critically short supply.

Disclaimer

The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.

Nothing herein shall limit or restrict the right of affiliates of Kailash Capital, LLC to perform investment management or advisory services for any other persons or entities. Furthermore, nothing herein shall limit or restrict affiliates of Kailash Capital, LLC from buying, selling or trading securities or other investments for their own accounts or for the accounts of their clients. Affiliates of Kailash Capital, LLC may at any time have, acquire, increase, decrease or dispose of the securities or other investments referenced in this publication. Kailash Capital, LLC shall have no obligation to recommend securities or investments in this publication as result of its affiliates’ investment activities for their own accounts or for the accounts of their clients.

June 3, 2022 |

Categories: Quick Takes

June 3, 2022

Categories: Quick Takes

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