|Oil gushes: Shares of energy companies have crushed the performance of tech stocks during the past two years.|
| * based on prices and earnings estimates as of 6/7/05 |
| Source: Thomson/Baseline|
NEW YORK (CNN/Money) -
Let's play a little word game, kind of like the ones they used to have on the SAT test.
Tech stocks are to the late 1990's as 'x' is to the mid-2000's.
If you said energy stocks, congratulations! You're one sharp cookie.
But seriously. With the price of crude oil surging above $50 a barrel, shares of big oil producers, refiners, drillers, natural gas companies and even coal miners have been the darlings of Wall Street the last two years or so, kind of like tech in the 90's.
Since the end of 2003, the Amex Oil Index and Philadelphia Oil Services Index are both up nearly 50 percent, compared to gains of just 3 percent for the Nasdaq and 8 percent for the S&P 500.
And even though crude prices have retreated a bit from record highs set earlier this year, investors have yet to flee the oil patch. Natural resources mutual funds are up more than 10.3 percent this year, making them far and away the best performing domestic stock fund category, according to Morningstar.
So what's next for oil and other energy stocks? Are they this decade's version of tech? And if so, is this the start of a prolonged rally for the sector or is it close to peaking?
Crude awakening. High prices here to stay?
Despite the big move the group has had already, many analysts and fund mangers think there's still room for oil stocks to run. So any mention of that dreaded B word is not fair, they say.
"This is different than the bubbles of biotech and the Internet," said Todd Campbell, president of E.B. Capital Markets, an independent research firm catering to institutional clients. "The fact is oil is a natural resource so there are capacity constraints that could keep prices relatively high."
To that end, there is a case to be made for oil prices staying near current levels for the next several years, said Knox Fuqua, manager with the AAM Equity fund.
In addition to long-term concerns about dwindling supplies, there's likely to be more demand from emerging markets like India and China, which have been big buyers of oil. And as those economies grow, Fuqua said consumer spending should lead to higher levels of energy consumption, just as it has in the United States.
"In the long run, oil could stay in this price range and as long as it does there's no reason to make changes to your portfolio," he said. "Right now energy stocks look good. People want to drive cars."
What's more, Dan Pickering, an analyst with Pickering Energy Partners, an independent research firm, thinks that earnings estimates for many energy companies are not based on prices staying in this range.
"Stocks clearly haven't factored in long-term oil prices at current levels, which we think gives them more upside," said Pickering.
Some stock picks from the oil patch
In addition, he said that earnings multiples for many oil companies, particularly oil services and drilling firms, remain below historical levels, which is odd considering that the sector is booming.
Pickering said oil services and drilling companies tend to trade at about 20 times estimates for the next year. And three of his favorite picks, Nabors Industries (Research), Noble Corp. (Research) and Baker Hughes (Research), are currently valued at 2006 price to earnings ratios in the mid-teens.
"We see opportunities for earnings to go up and multiples to expand," said Pickering.
Campbell also likes oil services and drilling companies because he thinks that big oil exploration and production companies are likely to increase their spending on new projects.
"Oil prices have remained high long enough that we are going to see nice increases in exploration budgets and that will start off a multi-year continued run for the drillers and services firms," he said.
Among Campbell's favorites in this group are equipment and drilling companies BJ Services (Research), Transocean (Research) and Schlumberger (Research) as well as oil transportation firm OMI Corp. (Research)
Fuqua thinks that investors should still have exposure to oil production and refining companies as well. As such, he owns industry giants Exxon Mobil (Research) and BP (Research) in his fund as well as smaller firms EOG Resources (Research) and Murphy Oil (Research).
Beware the super spike
Still, that's not to say that there are no risks. In fact, the biggest worry is not that oil prices will tumble, cutting into profits, but that prices may keep surging, a phenomenon that some on Wall Street have dubbed a "super spike."
That would probably lead to a global slowdown in demand for oil, which would crimp economic growth worldwide -- and thus hurt oil company earnings. After all, the weaker-than-expected initial reading for first-quarter economic growth in the U.S. was blamed largely on record high oil prices.
Pickering thinks that as long as oil stays between $40 and $60 a barrel for the foreseeable future, this should be a "sweet spot" that can support strong earnings growth for a wide swath of energy companies.
"Oil can go too high," said Pickering. "A super spike is great for commodity traders but bad for oil stocks."
For a look at more energy stocks, click here.
Check out CNN/Money's special Oil Crunch report on what high gas prices mean for you.