We believe investors should be open-minded about old-fashioned energy for two reasons. First, we have a growing conviction in oil companies’ capital discipline. Second, while commodity prices may rise due to severe underinvestment, they do not need to for the sector to become a massive profit engine for investors. Third, with broad market equity duration risk at records, energy offers a very cheap hedge.


  • On March 29th, 2020, we published a study on sector responses in crashes. With oil at negative prices, energy stocks down 61%, and industry consolidation underway, we believed that survivors of the carnage were a “…call option on the eventual resumption of even partially normal human behavior.”
  • In April 2020, we published an update noting that with total stimulus exceeding 30% of GDP, despite elevated valuations, stock selection would be key to strong performance.
  • In March of 2021, we published a study of the Great Inflation of the 1970s which showed that not only had Energy & Staples been some of the biggest beneficiaries of inflation, but that the market’s valuation structure was such that many popular sectors were priced like long term inflation was impossible. Watch our follow-up presentation on equity duration here and review our piece explaining what does volume in stocks mean today.
  • Since then we have written pieces that discussed the bubble in renewable energy companies, a piece explaining that ESG and brutal capital destruction were setting energy up for the virtuous cycle of capital discipline, rising free cash flow, deleveraging, multiple expansion, and healthy dividend yields.
  • A piece discussing soaring food prices due to drought and rising energy costs as well as a piece showing that magazine covers were giving their classic contrarian buy signal and showing energy has the lowest weight in the S&P 500’s history.

Fig. 1 below is at the heart of our first point of conviction – oil prices do not need to rise for energy stocks to see explosive growth in profits. When oil peaked at $140/b, the sector generated $53bn in FCF. The energy sector today has generated $35bn in FCF in the trailing 12-months, with oil at an average price of $52. This means, energy stocks are generating ~70% of the FCF despite oil prices being 63% lower than the prior peak.

This is simple and powerful evidence of the importance of capital discipline to overall sector profits.

Energy Generates 70 of the Profits Seen at Peak Oil Despite Oil Being 63 Lower


This is why the KCR team has such deep roots in data-driven behavioral finance.  The below chart shows how narrative can trump facts and profits for only so long.  The navy blue line is still the energy sector’s FCF.  But the light blue line is now the aggregate market cap of energy companies.

  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.

[1] So obviously Twain was not talking about value investing, but we hope you catch our meaning ☺

[2] https://www.economist.com/briefing/2020/11/14/value-investing-is-struggling-to-remain-relevant Note: We think the world of “The Economist”

[3] https://www.economist.com/briefing/2020/11/14/value-investing-is-struggling-to-remain-relevant Note: We think the world of “The Economist”

[4] https://www.investopedia.com/terms/s/shitcoin.asp

[5] Hat tip our long-time friend AR

[6] Value is defined as the bottom decile of Long-Term Earnings Growth


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.

September 8, 2021 |

Categories: White Papers

September 8, 2021

Categories: White Papers

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