Energy and financials have been the worst-performing sectors during this pandemic. But these two out-of-favor stocks are worth buying.
Buy low, sell high. That’s the basic idea, isn’t it? In order to do that, you need to buy stocks when they are on sale and sell them when they are flying high. In other words, you buy a stock when nobody wants it and sell it when everybody wants it. That’s easier said than done.
Stocks usually go out of favor for good reasons. Business stinks and probably won’t get much better in the foreseeable future. Who wants to own a stock like that? But these out-of-favor stocks and sectors are an ideal place to find companies with great businesses at fire-sale prices. Business will inevitably improve for the very best of these companies. It’s just a matter of when.
The current market offers many such opportunities right now. Sure, the market indexes have staged an epic rally from the March bottoms. In fact, the Dow and the S&P 500 are not all that far from an all-time high. The technology laden Nasdaq index just hit an all-time high. But these indexes can be misleading. Many stocks have been left out of the rally and are still wallowing in bear-market oblivion.
Of the 11 S&P 500 market sectors, the worst performers so far this year are by far Energy and Finance. In fact, these two sectors have been the worst performers on the index for the past one-year, three-year and five-year periods as well.
These are cyclical sectors that don’t do well in a recession. Oil prices crashed as demand for energy fell off a cliff during the pandemic lockdown. The industry was already grappling with an unfavorable supply/demand dynamic and the price crash was another kick in the head. It’s been ugly for banks as well. Interest rates again crashed to new all-time lows and loan demand plummeted during the recession.
But the economy will still need oil and gas. It will power the recovery. Banks have a crucial role in the economy and will surely find a way to prosper as the economy recovers. In fact, the market is factoring in a booming economic recovery in the quarters ahead. If that comes to fruition, circumstances should greatly improve in these two sectors in the not-too-distant future.
As well, when the market sours on a sector, it tends to shun all the stocks, even though some companies are far less damaged than others. For patient investors, it might be a good time to look at the very best stocks in these sectors. Here are two that stand out – the best energy stock and the best financial stock right now.
The 2 Best Out-of-Favor Stocks
Best Out-of-Favor Stock #1: Chevron (CVX)
Chevron is one of the world’s largest integrated oil and gas companies, with operations all over the world. The company is involved in every facet of the energy industry but revenue is heavily skewed toward exploration and production.
Chevron is exposed to oil and gas prices. However, it can compensate for lower prices because it operates with lower costs and higher margins than the other large integrated oil companies.
The tough energy market of years past made this company lean and mean with more upside leverage when things turn around. Chevron’s cost per dollar of business operating expenses produced has fallen from $18 in 2014 to under $10 today. Consider this: The stock produced positive returns amidst the energy sector bloodbath from 2014 to 2016. It should be able to hold up relatively well through this downturn. And think what it could do when things improve.
All large oil companies will benefit if and when the economy and the sector turn around. Chevron is special because it is in better shape to endure the downturn than any other large oil companies. It went into this recession in great shape. The company invested heavily in growth projects in recent years and had cut back on capital expenditures.
It also carries lower debt than its peers, boasting an industry-best 0.25 debt/equity ratio. It also has a strong cash position, a low payout ratio and the ability to preserve cash. For example, the company cut back project expenditures by $4 billion.
The company can turn a profit fast as things improve and it has strong leverage to benefit going forward. It has several projects that recently came online and now has peer leading production growth. Chevron also has a huge and growing presence in the Permian Basin, the largest shale oil producing region in the U.S. and, by far, the fastest-growing oil region in the world.
The stock is down 27% so far this year and is now priced 35% below the 2018 high. The cheap price has raised the dividend yield to a highly attractive 5.7%.
Best Out-of-Favor Stock #2: Bank of America (BAC)
Bank of America is one of the largest financial institutions in the world. It’s massive, with more than $2.3 trillion in assets. The bank is involved in every facet of the financial industry from business and consumer mortgages, lending, credit cards and deposit gathering to wealth management from its Merrill Lynch subsidiary.
BAC has huge scale and scope, with a massive retail banking network, a major presence in credit card issuance, top commercial operations and a top-notch investment bank. The wide moat gives the bank huge advantages in costs and switching costs for existing customers.
And the stock is cheap. It’s down 29% so far this year and 60% from the pre-financial-crisis high and sells at a price/earnings ratio of just 11, compared to a five-year average of 13.5, and 22 for the overall market.
Obviously this is a bank that will stay in business through the recession and benefit when the economy recovers. But there’s something else. The financial crisis was a banking industry disaster. As a result, banks had a lousy recovery amid the bull market since 2009. The banks are in far stronger shape in this recession and should perform much better in the recovery and bull market this time around.
BAC spent much of the last decade recovering from the hangover from the financial crisis, and its own ill-conceived acquisitions. It has honed its operations and become much leaner and meaner. Prior to the recession it was seeing rapidly increasing profitability.
Bank of America appears poised to benefit greatly when the economy recovers.
*This post has been updated from an original version.