1. How to use GuruFocus - Tutorials
  2. What Is in the GuruFocus Premium Membership?
  3. A DIY Guide on How to Invest Using Guru Strategies
Holly LaFon
Holly LaFon
Articles (8613)  | Author's Website |

Causeway Capital July Newsletter -- A Study in Cyclicals: Energy Stocks and the Causeway Curve

Generally, the best value stocks carry the heavy weight of investor skepticism

July 12, 2017 | About:

Generally, the best value stocks carry the heavy weight of investor skepticism. Perhaps nowhere is this burden more evident today than in the global energy sector. Energy companies exhibit cyclicality in their revenue growth and earnings, traits that investors have shunned in recent years in favor of steady, reliable growth. Relative to high-flying information technology sector stocks, including semiconductor and semiconductor equipment manufacturers, the recent performance of energy equities looks particularly abysmal. As an aside, we caution that the last time markets ignored the cyclicality of technology was in the late 1990s.

Of course, cyclicality is not only to blame for investors’ current distaste for energy stocks. Investors may be worried about

a global glut of crude oil, especially from rising US shale oil production. Pessimists refer to the seemingly endless improvement in US shale productivity (as marginal costs fall, producers can boost wells and drilling), and possible lack of OPEC production volume discipline as reasons to abandon energy stocks. Furthermore, they argue that weak demand from Europe for refined product drags down the global demand outlook. Longer term, investors may also harbor fears of substitution effects from a proliferation of electric vehicles. Despite the naysayers, we currently see a

promising trajectory for oil & gas prices based on our research in the sector. In Causeway’s view, the energy industry offers the potential for improved profitability from operating efficiencies, enhanced by a modestly rising crude oil price.

Many economically cyclical value stocks appear on Causeway’s weekly screens when their revenue growth slows or shrinks, profit margins narrow, and their returns on capital decline. For illustration, we have included Causeway’s fundamentals curve. Our job is to seek to understand where companies are on that curve. With that information, we can make buy or sell decisions.

At the top of the curve, companies typically grow revenues, expand profit margins to peak levels, and generate returns on capital well in excess of the cost of that capital. Those appealing returns attract more investment and thus more competition, eroding returns for the industry and pushing

companies down the curve. Conversely, as low returns drive companies and capital out of the business, returns for the remaining participants improve. As fundamental analysts, the more accurate our estimate of a cyclical stock’s location on this curve, the less time, in general, our clients will likely need to wait for a stock’s performance to improve. For portfolio candidates, we fundamentally derive the stocks’ target prices using a two-year time horizon. We want to invest near the trough of the curve, so our clients reap the benefits of the recovery over that period.

To illustrate this analysis, we highlight a sample US oil & gas company that we will call E&P Co. An efficient and independent exploration & production company, E&P Co. has core holdings in the Permian Basin region of West Texas known as the Midland Basin as well as the Eagle Ford Shale.

Continue reading here.

About the author:

Holly LaFon
I'm a financial journalist with a master of science in journalism from Medill at Northwestern University.

Visit Holly LaFon's Website

Rating: 0.0/5 (0 votes)


Please leave your comment:

Performances of the stocks mentioned by Holly LaFon

User Generated Screeners

jjhgef131 BB
aboer52DN Prof▼5Pred▼1Pi▼5JG▼
DBrizanAM 23Jun2018 1252Ap
DBrizanAM SD23Jun2018 1235Ap
alberto.lopezblancoMulti Ratio
hcjeversgood companies
pbarker46Begin here 000
Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)

GF Chat