I first invested in Chevron (CVX, Financial) at the beginning of November 2013. According to my notes at the time, I believed that the company looked undervalued compared to its potential over the next 10 years. It seemed to me that the market was ignoring Chevron's position in refining and offshore, as well as the quality of its reserves.
Compared to its peer, Exxon Mobil (XOM, Financial), which commanded a far higher multiple, it seemed to me that at the time, the market was willing to award the larger company the benefit of the doubt and give it a higher valuation. I thought this presented an opportunity to capitalize on Chevron's growth potential and plans to return significant amounts of cash to investors over the following years.
As it turns out, I was on the right track, but I wasn't willing to stay around long enough to find out.
Learning from mistakes
Part of my investment process is reviewing old investment ideas. I like to go back and analyze how positions performed, both during and after I owned the assets, to see if I can learn anything to improve my investment process in the future.
Soon after I bought a position in Chevron, the price of oil collapsed. The shale oil boom in the U.S. caused a glut in the market and sent tremors through global energy markets. Chevron's profit evaporated, and the value of the company's shares tanked. By August 2015, the stock I'd bought in 2013 for $120 a share was worth $80.
I did not sell at that point because I believed the company's strengths would work in its favor throughout the crisis. I was correct. Chevron's strong balance sheet and diversification enabled it to move through the oil price plunge and emerge stronger on the other side with a smaller cost footprint. The company also maintained its dividend. I cannot understate the psychological importance of receiving a dividend from a company under significant pressure.
Some investors may not chase dividends, and I do not always invest for income, but in this case, the distribution helped me weather the storm. In fact, thanks to this income, I earned a positive return overall when I sold the stock in mid-2017 (for personal reasons, nothing to do with the company's performance).
Changing environment
A lot has changed since 2013, and so has Chevron. Watching the business and the oil market develop over the past eight years has been fascinating.
The company is finally coming close to matching its peer Exxon on valuation. At the time of writing, following a strong rally in the stock, Chevron has a market value of $245 billion compared to Exxon's $300 billion. Over the past decade, the stock has returned nearly 5% a year including dividends, compared to 1% for the sector as a whole.
I have learned a couple of critical lessons from watching the business. Firstly, if one is going to invest in the resource sector, one needs to be prepared for volatility and have an incredibly long-term perspective. Commodity cycles take decades, not quarters. I was unprepared for this when I first entered the position.
Secondly, dividends can be a vital component of total return for cyclical businesses. If it takes a decade for a cycle to turn, investors may be left underwater for 10 years, and dividends can help soothe the pain.
Third, Chevron has been able to pull through the uncertainty of the past decade thanks to its diversification in petrochemicals, and its fortress balance sheet. These factors suggest that if one is going to buy companies in the resource sector, focusing on diversified enterprises with solid balance sheets is the best course of action.
Of course, the simplest solution for many investors may be to avoid the commodity sector altogether. That is certainly one answer, although I think the sector often throws up some interesting opportunities that are worth considering.
