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Oil Prices Have Been Tanking. Why Oil Stocks Are Gaining.Oil Prices Have Been Tanking. Why Oil Stocks Are Gaining. Barron's (Online); New York The price of oil has dropped while oil stocks have risen. There is a method to the market's madness. West Texas Intermediate crude oil has fallen just over 9% to below $97 a barrel in the past month. But investors don't seem to think it will fall a lot more, and have concluded that oil companies can be highly profitable at that price. Of course, OPEC is meeting this week and any production move that changes oil prices will affect oil stocks. The Energy Select Sector SPDR exchange-traded fund (ticker: XLE) is up about 6% in the past month. One reason is that the aggregate per-share earnings for energy companies in the S&P 500 for the second quarter have beaten expectations by 12%, according to Credit Suisse. That is backward-looking, of course, but it underscores how profitable the oil business is these days. Indeed, the price of oil is finding a floor—a good sign for the commodity. Crude oil has found buyers to prop up the price in the mid-90s range since March. That price area represents a "Russia premium." Just before it became imminent that Russia would invade Ukraine in February, oil was just under $90. Once markets anticipated an invasion and the subsequent sanctions on Russian oil, the price of oil went up. Technical analysts have recently noted that oil has gotten buying support in the mid-90s and that if it were to break below that level, oil stocks could drop , too. That hasn't happened yet. As long as the price of oil stays where it is, oil producers can keep churning large profits—and returning cash to shareholders. An elevated oil price keeps sales and profits high—and cash returns high as well. Most oil producers are returning the majority of their free cash flow to shareholders via dividends and share buybacks, so the total cash return yield against the price of oil stocks is fairly high, keeping investor money flowing into these names. "There is certainty that they're returning a lot of free cash flow," said Gabriele Sorbara, an analyst at Siebert Williams Shank. Devon Energy (DVN) is a perfect example. The company reported $1.9 billion of free cash flow for the quarter, above the expectation for $1.75 billion. The company returned just over $1 billion of cash to shareholders through dividends and buybacks. Investors can expect more than $5 billion of cash returns annually, which amounts to about 13% of the company's market capitalization. That means investors are getting a lot of bang for their buck when they pay to own the stock. That is another way of saying "the group is super cheap," Sorbara said. And that should keep money flowing into these stocks for now. |
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