Oil Stocks: A Metaphor For an Investment Philosophy

Sungarden Investment Research Article of the Week

by Rob Isbitts, Sungarden Investment Research

It is no secret that oil prices have been falling…and falling…and falling. The impact has been felt not only in the futures pits where oil, gasoline and natural gas are traded as commodities, but in just about anything related to the price of energy.

Possible causes:

1. A global political squeeze on Russia, Iran and other major oil exporters
2. A weakening global economy
3. A change in the long-term supply/demand for traditional fossil fuels (thanks to energy efficient cars, US energy discoveries, etc.)
4. Some combination of these and other factors.

The energy stock drama of the past several months is a very good metaphor for investing in general. That is, how an investor has responded to the (potentially temporary) decline in energy prices may say a lot about their general investment philosophy. Why? Because energy is an essential part of the global economy. There are companies that drill for oil or natural gas, those that process and refine it into products and others that transport and sell those products (e.g. gas stations). These businesses are all impacted by the price, supply and demand environment surrounding energy. Lately, they have nearly all been losing investments.

As always, an investor could hold what they owned, buy on the dips, sit it out or do some combination of these. The more detailed your portfolio management approach, the more decisions you had to make on this prominent economic sector.

What did we do at Sungarden?:

1. As part of our normal process, we had specific “lines in the sand” (i.e. price at which we re-evaluate with expectation of selling) for each energy stock we owned, so that we could act rationally and not in a panic
2. We held onto our “Core” holdings, the ones we expect to own for a very long time. We feel their business models are the most sustainable we follow, and we understand their stock prices will fluctuate from time to time.
3. We were initially patient with our “Resident” holdings, the ones we help to hold for at least a year. But as was the case with our energy residents, we are willing to sell them if they break those lines in the sand. They did, so we sold them early on in the energy rout to redeploy that capital into where we felt there was better upside potential over the next 1-2 years.
4. We sold our “Guest” holdings. These are the ones that we own for shorter-term purposes, as we are not comfortable holding them for years at a time. This is often due more to the way the stock trades than the underlying business itself. In fact, most of the companies we follow that are in commodity-related businesses like energy are classified by our research team as Guests.

We do believe that they are getting closer to the point at which they will start to look interesting again. This would not be the first time we saw a sector left for dead, only to have investors look back some time later and kick themselves for ignoring a fire sale. We’ll see what happens next.

Bottom line: have a process for everything you do related to making investment decisions. Or seek to learn from someone who does.