When energy stocks look like bargains

  @Money April 25, 2013: 6:29 AM ET
caterpillar stock

Caterpillar and other heavy-equipment makers stand to gain from expanding mining and drilling operations.

(Money Magazine)

Given how much time I spent in 2012 discussing an American economic renaissance fueled by low interest rates and falling energy prices, I was surprised at year-end when a CNNMoney forecast of market watchers predicted stocks in 2013 would gain just 4.5%.

The Dow and S&P 500 have already risen more than twice that, besting their 2007 records and prompting the question, "Now what?"

Valuations don't suggest a snarling bear is about to pound at the door, but after a 120% run-up since March '09, stock prices clearly are no longer low.

Even the bullish money manager Laszlo Birinyi, who correctly shouted "buy" at the nadir of the financial crisis, admits that he'll "reassess" stocks when the S&P 500 gets to 1600. As of early April that was a mere 30 points away.

Related: 4 ways the market could really surprise you

One game plan for the cautiously bullish is to invest in stocks that pay dividends, especially those that have a record of growing their payouts. Dividend stocks have outperformed the broader market over time, and consistent dividend growers tend to have strong balance sheets and dependable cash flows. Investing in such stocks is a sound long-term strategy, but for now they've had a good run that you can't assume will necessarily continue.

Think cheap

So here's another option: Find a deal. Search for a beaten-down corner of the market that could be poised to play catch-up.

The prices of energy-related stocks were hit by the slowdown in global growth last year, but as the U.S. economy improves and America's energy boom gains traction, energy service firms look like a bargain.

Coal stocks worse than lump of coal

National Oilwell Varco (NOV, Fortune 500) provides mechanical components for land and offshore oil rigs, and it stands to benefit as oil and gas exploration and production companies ramp up. The stock's price/earnings ratio is 12, less than the industry average and the market as a whole. Annual long-term earnings growth is projected to be 14%.

Caterpillar (CAT, Fortune 500) and other large-equipment companies should gain from expanded mining and drilling operations. With more than half the company's sales coming from outside the U.S., the stock has seesawed through the post-recessionary period as important markets such as China and Europe stalled. But with a P/E ratio of only 10, CAT appears to be undervalued.

"The heavy equipment segment will come back when capital spending commitments pick up again," says Ned Riley of Riley Asset Management in Boston. "The short-term disappointments have been discounted already, and the stocks are now better buys than they were before."

Related: Money 70 - Best mutual funds and ETFs

To diversify your exposure to energy services firms, look to the SPDR S&P Oil & Gas Equipment & Services ETF (XES). Holdings include all the major players, such as Halliburton and Helmerich & Payne. The fund charges 0.35% of assets, so it's an inexpensive way to buy into an inexpensive sector. To top of page



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