Among the multitude of market clichés, perhaps the most tired of all is the old axiom that traders and investors should buy low and sell high. It is a classic truism, but does have the advantage of reminding us that in certain circumstances stock moves are destined to be temporary and can provide contrarian opportunities. All the evidence and frequently repeated history suggest that that is the case now with the drop in big oil stocks, and XOM in particular.
Successful investing in the energy sector, and especially in integrated oil company stocks, is about understanding the cyclical nature of markets. The sector responds in the short-term to fluctuations in the price of oil and to broader stock market gyrations, but integrated, multinational oil companies are set up to survive through such things and to use the downturns as opportunities to consolidate and invest to prepare for the eventual recovery. As investors, we should do the same.
Timing still matters, of course, but when these stocks are close to significant recent lows, as many of them are right now, it is not a time to fear further declines, but rather a time to add to holdings. After all, even as oil has plummeted, Exxon Mobil (XOM) has continued not only to make money, but also to maintain, and even increase, the dividend paid to shareholders. Despite that, the stock has done this…
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Now I understand that markets are forward discounting mechanisms and the drop in price seen here reflects fears about further declines in both oil and natural gas and wider concerns about the effects of transition to a post fossil fuel powered world. At some point, however, we have to stop worrying about the future and pay attention to hard evidence. That evidence shows that while 2015 and 2016 were undoubtedly difficult years for XOM as they adjusted to the rapid decline in oil prices, they have continued to make good profits. With costs now cut significantly and improving prospects for global growth it is hard not to feel that worst is over.
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As I said before though, timing still matters and there is still a risk of something like the collapse of OPEC’s production cutting agreement precipitating a rapid drop at some point. The long-term future of XOM may look fine given what they have achieved as prices have plummeted, especially with a very friendly White House and Congress here in the U.S., but that doesn’t mean that you should neglect basic trading discipline. Stop loss orders should still be used to protect against further rapid declines, and the current proximity to lows allows for them to be set at a logical level that controls risk.
As you can see from the chart above, XOM has been basically trading sideways for around five months, forming a solid looking base in the process. The actual low this year is at 79.26, so allowing room to overshoot that level, somewhere around $77 is a sensible level for a stop. That represents a potential loss of just under five percent of your investment, which, when compared to the potential fifteen percent profit that would result from just a simple return to December’s levels for XOM, makes for a trade with a good risk/reward ratio.
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To some extent, getting back to those December levels requires a recovery in the price of oil, but given the rapid bounce following the most recent drop and the fact that WTI was only around twelve percent above current levels at the start of that month that doesn’t look out of the question. Even if the bounce falls short of that level though, the cost reductions over the last couple of years mean that profits, the ultimate driver of stock price, can climb back as the friendly regulatory and legislative environment allows for expansion of domestic production.
In this case buying low, albeit with some degree of sensible risk control looks like the way to play XOM. At some point the stock will bounce significantly, and preparing for that now looks like a smart move.
