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These companies are expected to be the fastest earnings growers in the cheap S&P 500 energy sector

By Philip van Doorn

Nearly half the companies in the S&P 500 energy sector are expected to increase earnings per share at a double-digit annual pace

(Updated with Wednesday's announcement of ConocoPhillips' deal to acquire Marathon Oil Corp.)

Energy stocks as a group are cheaply priced to expected earnings, even though the sector has been the best performer in the S&P 500 over the past three years, by far.

A month ago we looked at all 23 stocks in the S&P 500 SPX energy sector to see which ones had achieved the highest returns on invested capital over the previous three years. That analysis is still useful, although we are now down to 22 stocks in the sector, because Exxon Mobil Corp. (XOM) completed its acquisition of Pioneer Pioneer Natural Resources Co. on May 3. There are two more pending takeout in the S&P 500 energy sector. On Wednesday, ConocoPhillips (COP) agreed to acquire Marathon Oil Corp. (MRO), in a deal that might be the last of the big ones during this consolidation wave for U.S. oil producers. Back in October, Hess Corp. (HES) agreed to be acquired by Chevron Corp. (CVX), in an all stock-deal valued then at $53 billion.

Sector valuations and expected growth rates

Before looking at the individual stocks, let's take a look at weighted stock valuation, performance and estimates for the 11 sectors of the S&P 500.

Here are current forward price-to-earnings valuations and those a year ago, based on rolling 12-month earnings-per-share estimates, along with total returns with dividends reinvested for the sectors, which are in alphabetical order with the full index at the bottom:

   Sector or index           Forward P/E  Forward P/E one year ago  10-year average P/E  Current P/E to 10-year average  3-year return  10-year return 
   Communication Services          18.90                     16.80                18.92                            100%            20%            146% 
   Consumer Discretionary          24.24                     25.23                26.12                             93%             7%            212% 
   Consumer Staples                20.45                     19.83                19.49                            105%            22%            139% 
   Energy                          12.10                     10.48                15.42                             78%            98%             46% 
   Financials                      15.16                     12.56                14.20                            107%            17%            186% 
   Healthcare                      19.42                     17.06                16.49                            118%            22%            192% 
   Industrials                     21.20                     17.82                18.85                            112%            26%            177% 
   Information Technology          28.62                     24.98                19.45                            147%            70%            650% 
   Materials                       20.31                     16.11                16.68                            122%            11%            131% 
   Real Estate                     16.47                     15.99                18.86                             87%            -4%             92% 
   Utilities                       17.26                     16.81                17.37                             99%            19%            141% 
   S&P 500                         20.74                     18.10                18.12                            114%            32%            236% 
                                                                                                                                       Source: FactSet 

The energy sector is, by far, the least expensive of the 11 sectors in the S&P 500, despite having the highest three-year total return. But it has had the worst 10-year return, not only reflecting the crash in oil prices from mid-2014 through early 2016, but investors reluctance to loan up again in that sector.

This may still be a good time for long-term investors to consider the energy sector, according to Clare Hart, the lead manager of the JPMorgan Equity Income Fund. During an interview with Barbara Kollmeyer, Hart said she was "pretty bullish" on the energy sector, in part because of the opportunity brought about by investors shying away from fossil fuels. Her fund holds shares of ConocoPhillips (COP), Chevron and Exxon Mobil, which she said were examples of companies it was important to hold as they became more efficient and "environmentally friendly."

Last week Sandip Bhagat, chief investment officer at Whittier Trust in Pasadena, Calif., names energy among a group of "neglected sectors" (also including industrials, materials and financials), that he expected to "play a bigger role over the next five years than they have over the past five years." For energy in particular, he takes comfort that companies are "far less leveraged than they were in the past."

But the energy sector's relatively low valuation might also be influenced by subdued expectations for growth over the next two years. From a 2024 baseline, here are expected weighted compound annual growth rates for revenue, earnings and free cash flow per share, based on consensus estimates among analysts polled by FactSet:

   Sector                    Two-year estimated revenue CAGR through 2026  Two-year estimated EPS CAGR through 2026  Two-year estimated FCF CAGR through 2026 
   Communication Services                                            5.8%                                     13.0%                                     11.3% 
   Consumer Discretionary                                            7.1%                                     16.1%                                     16.0% 
   Consumer Staples                                                  4.3%                                      7.9%                                      9.9% 
   Energy                                                           -0.3%                                      8.2%                                      7.7% 
   Financials                                                        4.8%                                     11.7%                                       N/A 
   Healthcare                                                        6.2%                                     14.4%                                     12.2% 
   Industrials                                                       8.6%                                     15.9%                                     16.7% 
   Information Technology                                            5.4%                                     13.6%                                     15.9% 
   Materials                                                         3.5%                                     12.8%                                     26.1% 
   Real Estate                                                       6.4%                                      6.8%                                      9.9% 
   Utilities                                                         3.9%                                      8.1%                                    -49.1% 
   S&P 500                                                           5.8%                                     13.2%                                     15.0% 
                                                                                                                                              Source: FactSet 

A company's free cash flow is its remaining cash flow after capital expenditures. This is money that can be used to raise dividends, buy back shares, fund acquisitions or for other corporate purposes.

Read: Apple spent $645 billion on buybacks in a decade. These companies were even more effective.

So the cheapest sector by forward P/E is expected to be the only one to show a decline in revenue over the next two years. The energy sector has the second-lowest expected growth pace for earnings per share and the second lowest for free cash flow.

Expected growth rates for S&P 500 energy stocks

One way to invest in the entire S&P 500 is the Energy Select SPDR ETF XLE, which holds all 22 stocks in the sector, weighted by market capitalization. That means Exxon Mobil makes up more than 26% of the portfolio, and the top three holdings (with Chevron and ConocoPhillips) have a 52% weighting.

Now let's look at the growth pace estimates for the 22 companies in the S&P 500 energy sector. The companies are ranked by market cap and the table also includes forward P/E ratios and those a year ago:

   Kinder Morgan Inc. Class P     Ticker   Market cap. ($bil)  Two-year estimated sales per share CAGR through 2026  Two-year estimated EPS CAGR through 2026  Two-year estimated FCF per share CAGR through 2026  Forward P/E  Forward P/E one year ago 
   Exxon Mobil Corp.               XOM                   $509                                                 -2.3%                                      4.9%                                               13.6%         11.9                      11.0 
   Chevron Corp.                   CVX                   $291                                                  0.5%                                      7.4%                                                9.0%         11.8                      10.9 
   ConocoPhillips                  COP                   $137                                                  1.3%                                      5.1%                                              169.5%         12.7                      10.4 
   EOG Resources Inc.              EOG                    $71                                                  3.5%                                      3.1%                                                8.0%         10.2                       9.3 

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06-01-24 0659ET

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