Warren Buffett’s Energy Stock Affection and Insights on Insider Buys

Warren Buffett, renowned for his investment acumen, has taken a notable interest in the energy sector, particularly through Berkshire Hathaway’s substantial investment in Occidental Petroleum. But Buffett isn’t navigating these waters alone; he is joined by a wave of insider buying at energy companies, signaling a robust investment appeal in this sector. According to Vickers Insider Weekly, the energy sector has been highly favored among insiders for four of the past five weeks leading up to September 16.

Buffett’s buy: Occidental Petroleum

Buffett’s admiration for Occidental Petroleum isn’t unfounded. The company boasts strong cash flow and significant holdings in the U.S. Southwest’s Permian Basin, making it a low-cost producer. This focus on profitable operations aligns with Buffett’s investment philosophy which leans toward companies with solid fundamentals. Additionally, insiders buying into these energy stocks suggest that they perceive long-term value that the market may not currently recognize.

Energy Sector: Out of Favor but Poised for Growth

Despite the bullish sentiment from insiders, the energy sector has been underperforming. It is essential to highlight that the S&P 500 Energy Sector Index has posted a decline of 1.1% in the past year, contrasting sharply with the S&P 500’s gain of 31.7%. Portfolio manager Ben Cook of Hennessy Energy Transition Investor (HNRGX) asserts that the long-term outlook for energy stocks remains positive, citing supportive commodity prices and growing earnings potential in the sector.

According to Cook, the enterprise value of the energy index stands at 6.8 times next year’s estimated EBITDA, which is significantly below the 10-year average of 7.9 times. This presents an attractive buying opportunity, especially considering energy stocks currently exhibit free-cash-flow yields ranging from 8% to 10%—more than double the average S&P 500 stock. Notably, while energy companies contribute around 10% of the S&P 500’s earnings, their market capitalization only accounts for 5%, suggesting a misalignment that could correct over time.

The Case for Energy Investments: Insights from Experts

Multiple factors underline the current undervaluation of energy stocks, as discussed by various energy-investing experts. Cook notes the enhanced shareholder focus within energy companies, characterized by disciplined capital spending, which has fostered strong free cash flow. This disciplined financial stewardship allows companies to return capital to shareholders through dividends and buybacks, prompting insiders to invest despite potential market volatility.

Additionally, the price of oil could rise due to geopolitical tensions, particularly in the Middle East, which remain unaccounted for in oil pricing. Cook asserts that global interest rate cuts will also create a favorable environment for energy demand, with growth in less-developed countries leading to increased energy consumption. He emphasizes, “A growing global economy and pursuit of higher quality living ultimately mean an increased need for energy.”

Supporting Factors: Demand, Supply, and Oil Prices

Amidst these dynamics, U.S. energy producers exercise capital discipline, keeping supply in check while global demand for energy continues to rise. Tortoise Energy Infrastructure Total Return Fund (TORIX) manager Robert Thummel forecasts global demand to grow in tandem with world GDP growth. “Fossil fuels comprise over 80% of the global energy supply,” he adds, suggesting minimal dramatic changes in this landscape over the coming decades. Compounding this is the fact that global inventories and the U.S. strategic reserve are below historical levels, setting a stage for potential price increases due to heightened demand.

Favorable Political Climate for Energy Investments

Looking ahead, political outcomes in the U.S. could favor energy investments irrespective of party affiliation. Democratic administrations typically implement restrictive supply policies, benefiting energy stocks, while Republican sentiments toward increased production may be tempered by investor demand for cash flows and dividends over reckless expansion.

Top Picks in the Energy Sector

Cook from Hennessy highlights oil-services giants like Schlumberger, Baker Hughes, and Halliburton as undervalued stocks given their current challenges in the energy sector. He emphasizes quality companies with robust balance sheets including Exxon Mobil, Cheniere Energy, EOG Resources, NextEra Energy, and ConocoPhillips.

Thummel points out that Chevron appears excessively discounted due to exaggerated fears regarding foreign investments, while also singling out Diamondback Energy as a potential target for acquisitions among Permian Basin producers.

Conclusion

In summary, Warren Buffett’s endorsement of energy stocks, coupled with considerable insider buying, presents a powerful signal for investors. Despite the sector’s recent underperformance, analysts see a horizon brimming with opportunities, highlighting multiple long-term growth drivers. With disciplined management and supportive macroeconomic factors, it might just be the right time to consider energy investments as a compelling portfolio addition.