(MONEY Magazine) – Forget the hard times that have befallen tech investors. If you've held energy stocks in your portfolio over the past year, you've done just fine. As the S&P 500 dropped 14.6% and the Nasdaq sank 44.2%, the S&P energy stock index clocked a nifty 22.7% gain.

Despite their Old Economy roots, energy stocks deserve a place in every investor's portfolio. Energy is a large and critical part of the economy, and the sector includes some fabulously well-run businesses.

But investing in energy isn't simple--particularly right now. With the continued scarcity of oil and natural gas, it's natural to assume that the sector is poised to continue outperforming. Not necessarily. The energy sector actually consists of several disparate industries, each with its own risks and opportunities (see the box on page 40). Some of these subsectors have already seen their stocks run up dramatically. Others, like independent refining and marketing firms, might actually fare better if oil prices fall. So where's the opportunity right now? We see two specific stocks, in two energy subsectors, worth considering.

Oilfield services

The fat times of 2000 have filled the coffers of the big energy companies with cash. Now they've got to put that cash to work. One way they'll do that is by finding new oil and gas to own, which is why analysts expect exploration budgets to rise some 20% this year. That bodes well for oilfield-services companies, which provide the labor and equipment for drilling and exploration.

Many oil service firms had terrific runs during the past year (Nabors Industries is up 79% since we recommended it in our March 2000 issue). Our new pick in this subsector missed out on those good times. It's nearly 30% off its 52-week high. But that's why we like Schlumberger, the world leader in oilfield services. The stock poked along last year because its specialty, international deep-water drilling, remained relatively quiet. In February, Schlumberger announced a $5.2 billion acquisition of French tech firm Sema. Investors were confused--Schlumberger already drew 30% of its income from tech, so why would it pay so richly for a pure tech outfit?--and the shares quickly fell 8%.

We smell a buying opportunity. True, Schlumberger is less of a pure play on oil drilling than, say, Baker Hughes. But it has great strength in what will probably become the hottest segment of the drilling business, deepwater drilling. As analyst Scott Gill of energy-investment boutique Simmons & Co. explains, "The best values are going to be offshore drillers with an international slant." That makes its discount to large-cap rivals like Halliburton intriguing--its price/earnings ratio is 1.6 times its growth rate, while the others trade at more than twice their growth rates.

The diversification within Schlumberger might be an advantage in the long run. Sema sells software for wireless and network communications, which should help Schlumberger develop valuable ways of tracking resources and keeping crews in touch with their field offices. Still, it's that core business that we're counting on. This is the largest player in an extremely profitable industry where the barriers to competition (setting up deep-sea oil exploration equipment and the highly trained crews that run them) are intense. Schlumberger's not showing signs of giving up any market share. And right now, its price is enticing.

A major sleeper

In our June 2000 issue we recommended BP Amoco as a "safe harbor" stock. Since then, the share price has stumbled 11.4% from $55 to $48.73. But we're still bullish.

BP Amoco is one of the largest integrated energy companies in the world (the product of merging British Petroleum, Amoco and Arco), with a vast array of tempting businesses. Peter Fusaro, president of energy consultancy Global Change Associates (which has worked closely with BP), points out that the company owns the biggest natural gas portfolio in North America. And natural gas is the key source of electricity in the U.S. (95% of the recently built electric plants rely on it, according to Invesco Energy's John Segner). A Gulf of Mexico oil discovery announced over the past several months could give BP 75% of a possible 1.5-billion-barrel reserve. The company also has a fast-growing solar division--it sells solar energy in 150 countries and boosted sales in this area 31% over 1999. With the promise of revved up oil and gas production, BP looks like a "sleeper," argues Michael Hoover, manager of the Excelsior Energy and Natural Resources fund.

The scary thing about BP is that its profits are likely to drop this year. But cheaper oil is already baked into the stock price. Meanwhile, BP boasts a 12% annual long-term growth rate, according to analysts, and a P/E of 14.5. ExxonMobil, by contrast, has an 18.8 P/E and a long-term growth rate of just 8%. Plus BP Amoco can tide you over with a 2.9% dividend, second highest among the majors.

BP is well on its way to digesting the Amoco and Arco acquisitions--and it's developing an ambitious clean-fuels program in Europe. Last year, management cut costs by $2 billion, hiking its return on capital to 23% from 13%. As long as it enjoys a discount to its rivals, BP looks compelling.

--ALEC APPELBAUM