On Tuesday night I put together an article that discussed the impact of lower oil prices and the stock market. I called upon some academic research that found a relationship between lower oil prices and higher returns in the S&P 500, and I then came to the same conclusion from my own analysis into the matter.
On Wednesday, head of the Federal Reserve Janet Yellen seemed to agree with this point of view when speaking later at the FOMC press conference.
Yellen said that "lower oil prices were net positive for the US economy" and that they "put a bit more cash into the average consumer's pocket".
She also repeated that oil prices were "transitory", strongly suggesting that she doesn't believe oil prices will remain at these levels for very long.
This supports my own view and with oil having fallen by around 50% in 2014, it seems like the perfect opportunity to load up on oil stocks, which are now heavily discounted and trading at very cheap margins.
Here are my three best stocks in the oil space:
Three Of The Best
My standard approach to investing is based on a rules-based strategy that I have refined through back-testing on historical data.
Essentially, I look for stocks that meet a strict criteria of rules that abide by the value investing methodology akin to Benjamin Graham. This enables me to take a professional and disciplined approach to investing.
Putting these rules into the screener, I am left with around 20 companies, many of which are in the battered energy space. I then used my judgement to pick out three of the best stocks from the list.
Helmerich & Payne Inc (HP, Financial)
Top of the list of best oil stocks is this driller from Oklahoma.
HP has been in operation since 1920, has a market cap of $7 billion and has operations all over the States, South America, the Middle East and Africa.
The stock meets all of my criteria and looks attractive on almost every measure. PEG is under 1 at just 0.41, the PE ratio is 9.50, and the current ratio is 2.52.
This indicates that the company is in a solid financial position with a healthy balance sheet. It is surely one of the better-run oil drillers on the market, and this means it will be in a great place to benefit from the shake-out of the oil industry and the collapse of smaller players.
As you can see from the monthly price chart below, the stock is extremely oversold. If you look back to 2008, you can see that the last time the stock dropped so hard it went on to make quite staggering gains.
Finally, the Peter Lynch chart also suggest that HP is cheap. In fact, HP trades at a 34% discount to the Peter Lynch earnings line.
American Railroad Industries Inc (ARII, Financial)
ARII is a US manufacturer of railcars, hoppers, and railcar parts and is partly owned by Carl Icahn (Trades, Portfolio). Despite the huge drop in oil, ARII is fairly sheltered by the fact it has a backlog of orders extending past two years.
Like HP, ARII is trading at a hefty discount to its Peter Lynch earnings line. In fact, the stock trades at the same discount of 34%.
And also like Helmerich & Payne, ARII meets all my standard criteria for value and growth.
The PEG ratio is just 0.13, PE is 10.40 and the current ratio is 2.20.
This is a well-run company that has also been able to grow EPS at 22.60% over the last five years.
In terms of revenue growth, ARII is doing better than 99% of the 1,039 companies in the global railroads industry.
LyondellBasell Indutries NV (LYB, Financial)
LYB is an ADR stock that trades on the NYSE but is domiciled in the Netherlands.
The company is one of the largest plastics, chemicals and refining firms in the world with sales of $46 billion.
Despite that, the market cap of the company is now only $38 billion as the stock has dropped around 34% since September.
Again, LYB looks like a quality company that now trades at a discount as a result of the massive plunge in oil prices.
The stock has a PEG of 0.77 and a PE ratio of 8.40, it's lowest since 2012. The stock also has a healthy balance sheet with a current ratio above 2 and now yields a 3.7% dividend rate. As well, the stock now trades at a hefty 42% discount to it's Peter Lynch earnings line.
Round-up
As I mentioned at the beginning of this article, the drop in oil prices looks likely to be temporary and the bottom may well be very near.
This creates an opportunity to buy stocks and my reserch shows that lower oil prices leads to strong stock returns in the subsequent year.
In fact, a drop of 50% in oil points to S&P returns of 25% in the following year according to my analysis.
These three stocks are well positioned to withstand the fallout in oil this year and offer value investors great opportunities in 2015.
