The oil markets have been very volatile in recent years. In 2020, the price per barrel fell below $25, only to zoom past the $100 market two years later. The oil price is currently hovering around $70 per barrel. If you’re looking for oil stocks that can thrive in mixed conditions, the two companies below are for you.
Rely on superior capital allocation
Capital allocation in the oil sector can be difficult because a company’s survival is often prioritized over shareholder profits. For example, a company may get lucky with a particular reservoir and generate hundreds of millions of dollars in free cash flow over the life of the well. While it may be best to send this free cash flow back to investors, management often gets involved in empire building. That is, they acquire all kinds of additional assets that may not have the same return profile as the original put, potentially wasting the original golden goose.
All of this is to say that capital allocation is critical when it comes to identifying profitable oil stocks. How can we tell how well a company has done in investing shareholder wealth? Return on equity (ROE) gives us an idea of how much a company is worth earns for shareholders, while the return on invested capital (ROIC) captures the value creation debt and equity holders. On this front, Chevron (NYSE:CVX) – one of the most recognizable oil brands in the world – is looking pretty good, with long-term ROE and ROIC averages in the double digits.
It wasn’t always a smooth ride. Even Chevron has struggled to maintain its average return profile during recent volatility. But as the past two years have shown, Chevron has the financial strength and long-term vision to recover from operational challenges. And it’s not that the shares are too expensive. Shares trade at just 15 times earnings (about half the market average) and have a free cash flow yield of more than 6%.
It’s not the flashiest pick, but there’s a reason why Chevron stock has caught the attention of Warren Buffett, who owns about 6.5% of the company. Buffett likes companies that put the interests of shareholders first. And while it hasn’t always been perfect, Chevron has had decades of success.
Ensure more growth with this oil share
Warren Buffett isn’t just a fan of Chevron’s capital allocation. He loves too Western petroleum‘S (NYSE:OXY) CEO Vicki Hollub, who he says is “running the company the right way.” By this he probably means that it prioritizes profit over production – which, as mentioned, can be difficult to achieve when it comes to capital allocation.
By comparing Occidental’s ROE and ROIC metrics to Chevron, you’ll get an instant assessment of how each company is run. Chevron benefits greatly from allocating capital to midstream and downstream segments, including pipelines, refining and distribution.
These segments protect Chevron from market fluctuations because profits in one division can be used to offset losses in another division. For this reason, returns have remained relatively stable. Occidental, meanwhile, has experienced huge swings in ROE and ROIC as it relies heavily on its upstream business. That is, it is more exposed to fluctuating oil prices than an integrated producer like Chevron.
If Chevron is a reliable bet if you’re not sure where the oil markets are headed, then Occidental makes a great investment if you think oil prices will rise. to get up. After leveraging its balance sheet to acquire CrownRock — a shale producer with assets in the Permian Basin — the company is expected to generate about $260 million in additional cash flow for every $1 increase in oil prices. If oil prices were to reach 2022 levels, Occidental could generate more than $10 billion in additional cash flow – 20% of its current market capitalization.
Was the CrownRock takeover an attempt to chase profits? Or was it a wise strategic decision, in addition to the rest of Occidental’s capital allocation plan, which includes dividends, share buybacks and debt paydowns? The answer will depend on the direction of oil prices in the coming years. If you’re optimistic, there are few investment options superior to Occidental’s, given its direct impact on rising prices.
Should You Invest $1,000 in Occidental Petroleum Now?
Consider the following before purchasing shares in Occidental Petroleum:
The Motley Fool stock advisor The analyst team has just identified what they think is the 10 best stocks for investors to buy now… and Occidental Petroleum wasn’t one of them. The ten stocks that survived the cut could deliver monster returns in the coming years.
Think about when Nvidia created this list on April 15, 2005… if you had $1,000 invested at the time of our recommendation, you would have $839,122!*
Stock Advisor provides investors with an easy-to-follow blueprint for success, including portfolio building guidance, regular analyst updates, and two new stock picks per month. The Stock Advisor is on duty more than quadrupled the return of the S&P 500 since 2002*.
View the 10 stocks »
*Stock Advisor returns October 14, 2024
Ryan Vanzo has no position in any of the stocks mentioned. The Motley Fool holds positions in and recommends Chevron. The Motley Fool has a disclosure policy.
2 No-Brainer Oil Stocks to Buy Right Now with $200 was originally published by The Motley Fool
