In The Oil Sector, Bargain Stocks Are Everywhere

As you've probably heard, oil is getting crushed. After touching $100 per barrel earlier this year, West Texas Intermediate crude oil is now all the way down to less than $60 per barrel. Of course, this has had a dramatic impact on stock prices in the energy sector. The sentiment has gotten so bad that investors are selling out of oil stocks first, and asking questions later.

But as Foolish investors, we ought to question whether the pervasive fear has gone too far. While it's understandable to fear the financial futures of small, debt-laden companies with poor fundamentals, the market is also indiscriminately selling off highly profitable, large-cap stocks that pay sound dividends. For these reasons, investors not afraid to buy when there's blood in the streets should take a closer look at oil giants Chevron , ExxonMobil , and ConocoPhillips .

Be greedy when others are fearfulIt's entirely understandable to become fearful when stock prices decline. Racking up big paper losses can be daunting, and intimidate us out of investing. But quite often, the best time to buy is when nobody else will. Now that the attitudes about oil are almost unanimously negative, it might be just the time to step in and scoop up shares of highly profitable oil stocks.

Chevron, ExxonMobil, and ConocoPhillips are three great businesses that are currently in the discount bin. Here is a rundown of the compelling valuation opportunity that stands before investors.

Source: S&P Capital IQ.

These stocks trade at significant discounts to the market multiple. The S&P 500 holds a P/E of around 20, while the energy sector of the S&P holds a multiple of 13. These three companies are looking cheaper than their peer group, and are clearly undervalued given their cash generating abilities. Currently, Wall Street expects very little from this group, which explains their dramatic sell-offs in recent weeks. But there remains the possibility that these companies can outperform the low expectations embedded in their valuations, which is what happened last quarter. For example, ExxonMobil earned $1.89 per share in the third quarter, up 5.5% from $1.79 per share in the same quarter last year. This handily beat Wall Street estimates, which called for just $1.71 per share, which would have been a 4.4% decline. Chevron beat expectations as well, as earnings grew an impressive 14.7% last quarter to $2.95 per share. This easily beat analyst expectations of $2.55 per share.

ConocoPhillips is a higher-risk play than either Chevron or ExxonMobil right now, because it no longer operates a downstream business after spinning off its refining unit. Its status as an exploration and production operator makes it especially vulnerable to oil prices. This is why its adjusted earnings fell 12% year over year. Still, investors are compensated for these risks with an even cheaper valuation and higher dividend yield than its integrated peers, ExxonMobil and Chevron.

Plus, ConocoPhillips announced it will cut its 2015 capital spending by 20% compared to the previous year, to $13.5 billion. This is the right course of action and exactly what you would expect the company to do in light of such dwindling returns on new projects. Reducing capital expenditures will help maintain ConocoPhillips' cash flow.

Earnings set to decline, but value is still thereIt's very likely earnings from Big Oil will continue to decline in the fourth quarter and into next year. After all, oil has fallen dramatically this year. But the opportunity for Foolish investors exists because the drop in earnings appears priced in already. At less than six times enterprise-value-to-EBITDA, investors are earning at least a 16% operating earnings yield. This is in addition to their high dividend yields, which are also well above the market average.

The S&P 500 index yields approximately 2% right now, and these stocks are well above that. ExxonMobil is the lowest yield of the three, but at 3%, that's still 50% more income than what the broader market offers. Plus, these stocks provide the added advantage of strong dividend growth, even in the face of declining oil. If oil recovers even slightly, these stocks are sure to enjoy a relief rally. While the risk from a further deterioration in oil prices exists, it may be time to go bargain-hunting in the oil sector, under the belief that the sell-off has gone too far.

The article In The Oil Sector, Bargain Stocks Are Everywhere originally appeared on

Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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