With the price of oil falling by around 60% in the last six months, it’s been an incredibly challenging time for shareholders of oil companies. In fact, almost every oil company has seen its share price slide during that period, leaving shareholders of some nursing major losses.
Of course, the oil price could well go lower in the short term but, even if that happens, Premier Oil (LSE: PMO), Tullow Oil (LSE: TLW) and BG Group (LSE: BG) (NASDAQOTH: BRGYY.US) seem to be worth buying. Here’s why.
Margin Of Safety
As investors, what we’re really looking for is limited downside and unlimited upside (or at least as close as possible to that). The present situation regarding oil seems to present such a scenario, since the share prices of many oil producers appear to already have priced-in further any significant falls in the oil price that may (or may not) occur in the short run.
For example, using 2017’s forecast earnings (which are lower than those of 2015 and 2016 and therefore more conservative), Premier Oil trades on a price to earnings (P/E) ratio of just 8.4. Clearly, its earnings could fall by more than the forecast 40% in the current year and 12% next year. However, as mentioned, such falls appear to be adequately priced in, while the FTSE 100 has a P/E ratio of 15.6, thereby making Premier Oil highly appealing on a relative basis.
It’s a similar story with Tullow Oil and BG. For example, they both have price to earnings growth (PEG) ratios of just 0.2, which seems to scream ‘growth at a reasonable price’. Certainly, earnings forecasts could disappoint, but this eventuality appears to be priced-in.
Looking Ahead
While many commentators have attempted to predict the price of oil, it seems to be an impossible call. That’s because we don’t know how supply will be affected by the falling price of oil, with many people expecting the likes of Saudi Arabia to reduce production so as to maintain a higher price. This, though, has clearly not happened yet and, looking ahead, predicting the next move for the price of oil is more down to luck than judgement.
This, though, shouldn’t put investors off the sector. As ever, if there is a significant margin of safety on offer then it makes sense to buy and hold for the long term. And, in the case of Tullow Oil, BG and Premier Oil, their extremely appealing valuations, even when looking two years out at worsening earnings figures, seem to appeal on both an absolute and relative basis. As such, they could be star performers and seem to be worth buying at the moment.
