Tuesday, September 4, 2007

a 'low energy' approach

Our Canadian market, and thus the TSX (Toronto Stock Exchange) is very heavily weighted in energy stocks, (such as oil and natural gas producers), and material stocks (such as Aluminum or Uranium miners). As far as selecting stocks goes I feel less confidence roaming and researching in the energy space vs. the financial sector or consumer products areas.

My confidence in predicting future earnings is significantly lower with energy companies than it is with a consumer products firm. The reason for this is due to the fact that a barrel of oil or a unit of natural gas is worth varying amounts of money of different days. If I don't know what direction and at what rate the price of a barrel of oil will go, then I have a hard time predicting where the earnings of a company will go, that pulls this oil out of the ground and sells it. This makes it difficult for me to determine when an energy stock is cheap, fairly valued, or expensive going forward. Energy stocks need to be valued according to different metrics, because the traditional price/earnings ratio will give a skewed impression due to fluctuations in commodity price. These metrics vary depending on the school of thought that you subscribe to or which analyst you listen to. Whether it's price / cash flow, price/ book or net asset value...etc..............why bother......

All this being said, I believe energy is a good place to be invested in the medium and long term. With the continuing strong, energy dependant growth of many developing countries (ie China and India) as well as the ongoing energy apathy in North America, I believe the demand for oil, natural gas, and uranium will only grow. In my opinion this is a perfect sector to just take the guess work and homework out of it and buy the ETF (Exchange Traded Fund). Barclays iShares offers a product that I believe is perfect for exposure to the energy sector in Canada: iShares Canadian Energy Sector Index Fund (XEG).

The iSharesCDN Energy Sector Index Fund seeks to provide long-term capital growth by replicating, to the extent possible, the performance of the S&P®/TSX® Capped Energy Index through investments in the constituent issuers of such index, net of expenses. The Index is comprised of securities of Canadian energy sector issuers listed on the TSX, selected by S&P using its industrial classifications and guidelines for evaluating issuer capitalization, liquidity and fundamentals.

This exposure does not come without a cost as the MER (management expense ratio) is 0.55%, and the ETF will cost you your usual brokerage commissions to buy and sell. The benefits of this type of product are fairly clear though, as you receive immediate exposure to the largest energy names in Canada including trusts, for a reasonable price. Due to this exposure to income trusts XEG yields 2.50% in distributions (not strictly dividends), so you will pay relatively more tax on this income.

The top 3 holdings of this ETF (as of writing this) are:
Encana (ECA) 14.4%
Suncor (SU) 12.8%
Canadian Natural Resources (CNQ) 11.5%

Personally I will give strong consideration to XEG next time I feel the time may be right to buy some more energy exposure. For the time to be right sentiment on oil price should be low, and my portfolio should require some more commodity exposure to maintain proper diversification. This is one sector that I might want to take the low cost / low maintenance approach and just try to ride the tide of the sector long term.


FourPillars said...

Very interesting post.

I like the way you've identified areas that you feel comfortable buying individual stocks in (financials & consumers) and are buying ETFs for other areas.


FinancialJungle said...

Hey! I’m facing the exact same dilemma as well. I'm so cheap, I don't even want to pay the 0.55% MER. I can buy XIU, but that will overweight my financials. The current plan is to stick with the seniors.

Torbjorn said...

Cool. I think that’s a good ‘recommendation’ too. Sometimes I wait for the next dip (will we see one!?) before I go in, but I guess with a long time frame like mine it won’t matter too much. I also like Petro-Canada as a player, as their own investments are rather diversified given their play in the oil sands, connections to gas prices, and new projects out east too. I’m increasingly bearish on nearly all forest plays – Norbord (NBD) might have a fighting chance in the next little bit though…depending on world economy and homebuilding bullishness. They have European exposure which is a good addition.

As well I can relate to your previous post on Personal Finance and the Shabby Room. Especially living with my girlfriend (who generally comes from the moneytalk is taboo side), it all should be open to discussion as it’s only fair. I only recently started talking to others about my liquidity in savings, that took months to come into the discussion forum. If it at all causes pressure, release the pressure and learn to speak about it openly to keep things manageable. I like it, and it’s something I’m even proud of.

MG said...

Thanks for the comments everyone.

FJ, I still think XEG is a better bet than buying up seniors even with the MER.

Consider that you get trust exposure to boost your pay out as well you will reap the benefits of faster growing, smaller firms, or firms that make new resource finds or really accelerate growth in some other way.

WhereDoesAllMyMoneyGo.com said...

Just adding to the comment that the TSX is not a very well diversified market: Energy, Materials and Financials account for 75% of the total market.