We continue the Present Value of Growth Opportunities (PVGO) series this week by applying a slight variation of the model. Applying the traditional PVGO model to oil & gas majors fails to provide meaningful output due to recently burgeoning profits that the market does not expect will persist in the long term. Using trailing twelve-month earnings, the model suggests a deeply negative PVGO for all five companies.
However, we can normalize earnings via the average ROE method to get a more useful picture of the market’s growth expectations. We calculate a trimmed mean using the last 15 years of ROE data to exclude outlier years. Then we apply our normalized ROE figure to the book value of Equity lagged four quarters, arriving at our estimate of normalized EPS for the trailing-twelve-month period. The chart below illustrates the difference between the trailing twelve-month ROE and our normalized ROE figure.
Substituting normalized EPS for actual EPS in the PVGO model yields a much more reasonable outcome. As shown in the charts below, three of the five stocks have a negative implied perpetual growth rate, while the other two are near zero. On top of that, they still have relatively low P/E ratios after normalizing earnings. This is likely a manifestation of a “fossil fuel discount” being applied to the stocks by investors, whether for political reasons or risks to profitability.
If you expect these energy companies to remain a significant part of the economy in the long run, you might consider these worthwhile investments. The economy is expected to grow around 2% annually in the long run, while these stocks are priced for negative growth in perpetuity.
Company Summaries
Exxon Mobil Corporation (XOM)
Chevron Corporation (CVX)
Shell plc (SHEL)
Marathon Oil Corporation (MRO)
ConocoPhillips (COP)
Five for Friday
Five for Friday uses stock screens to produce five stocks that we expect will outperform if a particular investment theme plays out in the future. Investment themes may be relevant to the current or expected market, industry and/or economic trends. Investment themes may not always represent our current forecast.
Disclosure
This report is not a recommendation to buy or sell the named securities. We intend to elicit ideas about stocks meeting specific criteria and investment themes. Please read our disclosures carefully and do your own research before investing.
Michael Lebowitz, CFA is an Investment Analyst and Portfolio Manager for RIA Advisors. specializing in macroeconomic research, valuations, asset allocation, and risk management. RIA Contributing Editor and Research Director. CFA is an Investment Analyst and Portfolio Manager; Co-founder of 720 Global Research.
Follow Michael on Twitter or go to 720global.com for more research and analysis.
Customer Relationship Summary (Form CRS)