The energy sector – ORG, STO and WPL outperform

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I last reviewed this sector for the Switzer Super Report in November 2012 using data up to the close of 5 November 2012.

After now having been through the cycle of reviewing all sectors of the ASX 200, it is time to assess how our analysis performed over the last six months and suggest any new directions.

At that time I argued that the high conviction part of a superfund portfolio should focus on the biggest of the top 100 companies – but excluding those with a consensus rating of 2.5 or worse – that is better than a hold (1 is a buy, 3 a hold and 5 a sell). I excluded Worley Parsons and Caltex due to their being better classified as Industrials. I excluded Paladin and Whitehaven Coal because of undue risk. Since my last review, Paladin has fallen from the top 100 to the bottom half of the 200. Linc Energy left the top 200 to be replaced by Maverick Drilling

The stocks in the Energy sector of the ASX 200 are listed in Table 1 together with the capital gain – or change in stock price – and the consensus recommendation at the last review.

In the last review, we identified three stocks as fulfilling our requirements of being the biggest in the top 100 of the energy sector and with a rating better (lower) than 2.5. They were Woodside (WPL), Origin (ORG) and Santos (STO). Based on their then current recommendations and their one-year histories, I favoured them in the following order as STO, WPL and ORG.

The index for the sector grew by 5.9% over the same period – far less than the ASX 200 but a well-diversified portfolio often requires exposure to all sectors. Five stocks beat the index – Caltex (CTX), ORG, STO, Oil Search (OSH), and WPL. None of these were in the bottom half of the ASX 200. Since we have been through a testing time in equity markets, it is not surprising that smaller cap stocks performed relatively poorly. Since we excluded CTX on classification grounds, that leaves four outperforming stocks and all three in our ‘selection universe’ were in that set. Of course, there is an element of chance in the performance of stocks from my selection process but the methodology is designed to help the chosen set to outperform the index as a group and on average – not each time.Source: Thomson Reuters Datastream

As it happened, ORG finished above STO and WPL but an important maxim for investing is that one does not need to choose all of the best stocks – but just try and avoid the bad. There is nothing in the current data that makes me want to change my selection process for the next half year. But if I wanted to add a stock, OSH would now interest me with its new top rating in the top 100.

Going forward, it can be noted from Table 2 that the energy sector has the second highest (adjusted for current mispricing) forecast for growth over the next 12 months (22.3%) from Woodhall’s analysis. Currently the energy sector is rated as cheap; exuberance (or mispricing) is negative (-1.2%). The forecast yield is moderate at 4.0%.

At this moment, the market is a little ‘fearful’ by our Fear Index contained in our Woodhall Weekly. As a result, it may not be a good time to buy but, if the sector forecasts remain strong for energy, a buy might be appropriate as soon as the level of fear falls to back to normal levels.

Note: the estimates in the Table are current to the close of business 27 May 2013. They are based on Thomson Reuters Datastream data and Woodhall Investment Research’s analysis. Exuberance is a measure of mispricing with +6% our reference point for calling a possible correction or prolonged sideways movement. Cheap sectors (negative exuberance) can become cheaper! The capital gain for the following 12 months and the adjusted gain factors in the current level of exuberance.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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