Wednesday, January 21, 2015
Falling oil prices are hammering all types of oil stocks right now. But one type is suffering more than the rest...
Oil-drilling companies (the companies that provide drilling equipment and service crews to oil producers) are down an average of 55% over the past six months. And they just hit a historically low valuation.
But this could soon create a great opportunity for investors to make a lot of money.
Let me explain...
One of the metrics I use in my Stansberry Resource Report newsletter to monitor oil stocks is the price-to-book value (P/B) ratio.
P/B is simply a ratio of a company's market cap divided by the value of its assets (minus liabilities). Most financial reporting sites, like Yahoo! Finance, provide it for you (Yahoo provides the ratio on the Key Statistics page).
Over the past 25 years, the average P/B of the 12 largest U.S.-listed land oil drillers (like Helmerich & Payne and Rowan Companies) has been between 1.2 and just below 2.5. That means these companies typically trade between 1.2 and 2.5 times the stated value of their rigs, drilling equipment, etc.
But occasionally, the share prices of these stocks will plunge so much that their average P/B falls to an extreme level. It has only happened three times in the past 25 years. But after each of these times, oil drillers returned hundreds of percent over the next few years. You can see this in the chart below.
The red lines show the average P/B of these 12 companies.
As you can see, the last time the oil drilling P/B value reached an extreme was during the global financial crisis in 2009.
Back then, oil prices had fallen from $145 per barrel in mid-2008 to $34 per barrel in early 2009. Many oil producers decreased their production – meaning they needed less drilling equipment and service crews from oil drillers. And oil-drilling stocks plunged more than 70% over the same period. Their average P/B value fell to around 0.5. That meant you could buy these companies for less than the stated value of their assets. That's like walking onto a Ford Dealership's sales lot and seeing its cars selling for 50% off.
You see, the market doesn't put much value on a truck sitting in a yard. During a booming oil market, that same truck might trade at three or four times its value because it generates revenue. But during oil-sector busts, it's not worth what the company paid for it because so many of them are sitting around idle.
But because oil is tremendously cyclical (it goes through big cycles of boom and bust), the oil price eventually recovered... oil production picked up... and oil drillers soared. If you had bought all 12 of the largest U.S.-listed land oil drillers after oil prices bottomed, you could have made 321% in five years.
We're seeing a similar situation today.
Oil prices are down more than 50% since peaking in June. Many oil producers are cutting production. Oil-drilling stocks are down an average of 55% since oil prices peaked. And their average P/B is approaching 2009 lows. You can once again buy these companies for less than the stated value of their assets.
But eventually, oil prices WILL recover, just like they always do... oil production will pick up... and oil drillers will head higher.
We haven't seen oil prices bottom yet, so it's still too early to buy today. It's unlikely drilling activity will pick up until oil producers are confident the oil price has stopped falling. But once prices bottom, production will pick up and these stocks will soar.
There's no guarantee oil-drilling stocks will return as much as they did last time, but based on history, triple-digit gains are possible over the next few years once oil prices bottom.
While oil drillers are set to soar when the oil price recovers, Matt says there's one popular oil stock headed lower. "The company's spending is out of control, its profit margins are shrinking, and its debt is soaring. In short, [it's] a study in how not to run an oil company." Learn which company you should stay away from right here.
"Oil tycoon Harold Hamm is about to lose a lot of money," Brian Weepie writes. "He recently made a common investment mistake. It's one you could be making right now… and it could cost you." Get all the details here.
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