With Oil Prices So Low, Are Oil Stocks a Good Investment?

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Most of us have spent the past few years grimacing while standing at the gas station, watching the fuel pump digits go higher and higher as we fill up our tanks. This morning, however, I was smiling while filling up my tank because gas is now a bargain.

Are oil stocks also a bargain? And if they are, should you fill your portfolio with them?

In this article I explain just a few of the many ways you could invest in oil-related securities, if appropriate for your risk tolerance and investment objective, which is a conversation you should have with your financial adviser.

The Price of Oil Stocks Has Dropped Dramatically

If you are looking for stocks that you can "buy low," the oil sector warrants some attention. Over the past six months, Energy Select Sector SPDR (XLE) -- an exchange-traded fund focused on the energy sector -- has declined about 21 percent, while the S&P 500 (^GPSC) has increased nearly 5 percent. The Fidelity fund invests in more than 40 companies -- including Exxon Mobil (XOM), Chevron (CVX) and Schlumberger (SLB) -- that primarily develop and produce crude oil and natural gas and provide drilling and other energy-related services. Over the same period, SPDR S&P Oil & Gas Exploration & Production ETF (XOP), which invests in oil and gas exploration and production companies, fell more than 41 percent.

Finding Companies That Are Financially Robust

Some companies in the oil sector, including Seadrill (SDRL), have eliminated their dividends, which is often a sign of financial distress. Exxon Mobil and Chevron, in contrast, have paid and increased dividends for more than 25 years. Currently Exxon Mobil yields 3 percent, while Chevron yields 4 percent. Energy Select Sector SPDR yields 2.5 percent. So when considering whether to buy shares of an oil company or an ETF, make sure you understand the risk/reward trade-off of each option.

A Substitute for Trading Oil Futures Contracts

In addition to buying individual stocks or an ETF that invests in individual stocks, investors can also buy United States Oil ETF (USO), which tracks the price of light, sweet crude oil, as measured by the changes in price of the futures contracts traded on the New York Mercantile Exchange. The security has fallen more than 50 percent during the past six months.

When Will Oil Prices Hit Bottom?

How low can the price of oil go? And what will cause the price to go back up? I'm not an oil supply and demand expert, so my guess isn't relevant. Some brave souls are predicting the future price of oil while others are urging investors to stay away from certain oil stocks. As usual, there will always be bulls and bears.

If you own a mutual fund or ETF that mirrors the S&P 500, you already have exposure to energy stocks in your portfolio. It is your decision if you want to add more exposure while prices of such stocks are low. Just remember that when you increase your concentration of any individual sector, you increase your probability of increasing your return and your probability of a loss. That's what asset allocation and diversification is all about. Time is also a consideration. If you believe that oil prices will go up over the next few years and the oil stocks you choose won't go bankrupt while you wait, you might just gas up your portfolio by putting oil in it.

The information contained herein is strictly for educational and illustrative purposes, providing commentary, analysis, opinions and recommendations, and should not be considered investment advice for any specific subscriber or portfolio or an offer to sell or a solicitation to buy any security.
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