Energy, Energy Service, Natural Gas & Oil Sectors: Energy Sector - Capitalizing on Uncertainty?

» JenL_2 - Energy Sector - Capitalizing on Uncertainty?

In response to message posted by lcha:

Interesting speech Icha - Here's another example of how having knowledge of the industry can help one cut through the confusion and possible pick up some bargains. This from 7/12 SmartMoney.com - Stock Screen:

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Capitalizing on Confusion

By Cintra Scott

WHERE WILL CORPORATE earnings go next? Down? Up? Sideways? Well, Wall Street's current forecasts are really all over the map — especially in the energy and technology sectors. In other words, the supposed experts collectively have no clue. And we think this earnings uncertainty spells opportunity.

You see, companies with a wide range of earnings estimates tend to trade at lower valuations than comparable companies about which the future is more certain. So if you spot a good company stuck in a period of uncertainty, you might be able to pick up a bargain. And oddly enough, companies that confuse the experts may even make for slightly less risky bets than those about which the opinions are unanimous.

How's that? There's a better chance a company will report earnings somewhere within a wide range of estimates. On the flip side, if all estimates are the same or close to the same, a complete miss (and massive stock sell-off) becomes more likely. As Morgan Stanley U.S. Equity Strategist Steve Galbraith put it in his April research note (titled "Agreeing to Disagree"): "High dispersion of expectations signals opportunity while uniformity may signal risk."

So, to find wide estimate dispersions, we constructed a screen. We consulted with Prof. Lawrence Brown of Georgia State University, who is an estimate expert and editor of I/B/E/S International's "Annotated Bibliography of Earnings Expectations Research." Brown advised us to use a gauge called the "coefficient of variation," which measures the amount of disagreement in a company's earnings estimates.

To find the coefficient of variation, you divide the standard deviation of Wall Street's "consensus" estimate by the consensus estimate itself. (We put consensus in quotation marks because it's actually an average of analysts' estimates, not an agreed figure. The standard deviation measures how much estimates actually differ from this average.)

OK, that was the hard part, we promise. In our screen recipe, the first step was to sift through the earnings estimates tracked by Zacks Research Wizard, looking for companies with above-average estimate dispersion. We eliminated companies for which the consensus expects a loss in the upcoming quarter because the negative numbers throw off our ability to average the coefficients of variation.

To improve the quality of these results, we looked for stocks that have at least five analysts contributing to the consensus. We also decided to limit ourselves to midcap and large-cap stocks, since small caps and microcaps generally receive less individual attention. Finally, we demanded that our survivors display improved profitability but sport valuations below their historic norms......

After all our demands had been met, we had whittled a list of more than 7,000 stocks down to 42. The majority hailed from the energy and technology sectors, where debates about cyclical and secular trends are fiercest. Below, we discuss the attributes and uncertain fates of fallen tech star Sun Microsystems (SUNW) and energy-pipeline giant Williams Companies (WMB).

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Williams Companies

There's a similar case to be made for Williams Companies, which pipes in energy for businesses. Among our 42 screen survivors, the energy sector had the biggest showing (even bigger than technology). Basically, analysts can't agree how much longer energy prices will stay propped up. On top of that, it's in the process of acquiring Barrett Resources (BRR), an independent gas and oil exploration and production company. This stock is awash with uncertainty.

It's certainly true that oil and gas are famously cyclical commodities, and prices go up, and prices come down. But there are concurrent trends at work in the industry. Companies that have capitalized on the surge in energy prices are finding themselves with a lot of new cash, which can be used to pay down debt, buy productivity-enhancing equipment and make strategic acquisitions.

At the same time, Williams is in court with the state of California over the prices it (and other energy suppliers) has charged the state's utilities for natural gas. Settlement talks broke down Monday. It comes as no surprise that analysts have no idea how all these issues will affect the rest of the year's profits. According to Zacks, 19 analysts' estimates range from $1.40 a share to $2.75 a share for Williams calendar 2001.

But it seems Williams analysts can agree on one thing. All of them rate the stock either a Strong Buy or Buy, according to Zacks. Its low valuation could be a compelling reason to buy in. Williams trades for 15 times its trailing earnings, which is just a third of the cost of its five-year historic average of 45. And Williams trades for a little less than its oil-pipeline peers — based on its price/earnings ratio of 15 (vs. the industry's 16) and price/cash flow ratio of nine (vs. the industry's 10). If you're looking for a little uncertainty, almost anything in the energy patch will serve you well. If you're bargain-hunting for a lot of uncertainty, Williams is the stock to watch.

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<img src="http://chart.neural.com/servlet/GIFChart..." width=450 height=250>
WMB, XLE, IYE, S&P500 1 YR Chart

......Jen

-- posted by JenL_2