Energy stocks had another tough start Monday, falling more than 1 percent even after the sector concluded its 13th straight losing week. But the real bad news is that even after such a plunge, the sector’s valuation suggests energy stocks continue to be overvalued—leading some traders to see even more downside ahead.
Based on the next-12-months earnings estimate for the energy sector ETF (XLE), energy stocks are now trading at a price-to-earnings multiple above 24, making it the most richly valued sector in the market.
The forward P/E multiple, probably the most commonly used measure of valuation, compares current share prices to analysts’ estimates of the earnings companies will report over the next year. Often, relatively rich earnings multiples will imply heady growth prospects, with investors expecting a company (or sector) to report much higher earnings in the further-away future.
With energy companies, the story appears to be somewhat different. That is, analysts’ earnings projections generally integrate the current price of plunging oil. But investors seem to believe that crude prices will rebound over the next several years, making it rational to pay more today per each dollar of earnings expected in the next year.
Some bullish analysts are looking far into the future indeed. For instance, a recent analyst note from Stifel Nicolaus in which it maintained its bullish case for Kinder Morgan remarked that the company provides “growth opportunities well past the end of the decade.” The analyst, Selman Akyol, also noted that Kinder’s rich dividend makes it attractive on a yield basis.
But some warn that those getting into energy stocks right now are making a mistake.
Simply put, the sector “is expensive, and the fundamentals are very poor,” Gina Sanchez of Chantico Global said in a interview Friday on “Trading Nation.” Technical analyst Rich Ross of Evercore ISI added that it would behoove investors to “be late rather than early on this trade.”
Similarly, Wells Fargo institutional equity strategist Gina Martin Adams made use of a well-worn market metaphor in a Monday note, warning that “it may still be too early to catch the falling knife of energy stocks.”
But if oil prices manage to rebound, analyst earnings projections will likely rise with them. At the very least, that will make energy stocks appear less overvalued—though it’s unlikely to make them a conventional bargain.
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