The Tullow Oil (LSE: TLW) share price has risen by 20% in the last year. It now trades at around 240p having started the year at 200p. It has benefitted from stronger operating conditions across the oil and gas sector, as well as improving investor sentiment.
Furthermore, the company appears to have a sound strategy as it seeks to offer an improved risk/reward ratio. Could it therefore reach 300p this year, or are investors better off buying a more consistent FTSE 250 stock that reported a positive update on Tuesday?
Improving outlook
The prospects for oil producers such as Tullow seem to be improving. A rising oil price means that the entire sector is becoming more profitable, and this trend could continue over the medium term.
Clearly, the relationship between demand and supply is key to the industry’s outlook. And while there has been a rebalancing between demand and supply, this situation could change depending on factors such as OPEC production levels. As a result, investors may wish to seek wide margins of safety from oil and gas stocks in order to obtain a favourable risk/reward ratio.
Valuation
With Tullow Oil trading on a price-to-earnings (P/E) ratio of around 17.8, it seems to offer a narrower margin of safety than many of its industry peers. While this does not necessarily mean that further upside is limited, it does suggest that a share price of 300p may not be achievable in the current year. That’s not especially surprising, since the stock has performed well so far this year.
Of course, the company continues to seek higher levels of production in order to provide a more stable balance sheet. This could help it to warrant a higher valuation over the medium term, while exploration potential could cause investor sentiment to improve. As such, it could perform well in the long run, but with earnings due to decline over the next two years, its near-term upside potential may be relatively limited.
Solid growth?
Also seeming to offer a relatively narrow margin of safety at the present time is steam and industrial fluid control solutions specialist Spirax-Sarco (LSE: SPX). The company released a positive trading update on Tuesday, with it on track to meet its expectations for the full year. It continues to have good diversification across market sectors and geographic regions and it is in the process of implementing its growth strategy.
In the last five years the company has delivered positive net profit growth in each year. Further growth is expected in the next two years, and this consistent performance could appeal to some investors – especially if volatility returns to the wider stock market.
However, with Spirax-Sarco trading on a P/E ratio of 28, it now seems to be relatively overvalued. That’s especially the case since it is due to post a rise in earnings of 9% this year and 6% next year. As such, it may be a stock to avoid after its 17% gain in the last year.
