Wednesday, August 9, 2017

Evaluation of an Energy ETF

A Discussion of Vanguard’s Energy ETFs in Early August 2017

Question:   What are the PE ratios for the ten largest positions in VDE?  What is the aggregate PE ratio for these ten stocks?

Comment on the valuation of the energy sector in early August 2017.


PE ratios for Ten Largest Holdings of VDE
Company
P/E
Exxon Mobil Corp
33.36
Chevron Corp
71.6
Schlumberger Ltd
-47.3
ConocoPhillips
-36.2
EOG Resources Inc
-85.6
Occidental Petroleum Corp
-87.27
Phillips 66
26.38
Kinder Morgan Inc P
65.4
Halliburton Co
-10.46
Valero Energy Corp
14.82


Comments on these PE ratios:

  • Five of the ten firms have negative earnings and no defined PE ratio.


  • Only two firms Valero energy and Phillips 68 have a PE ratio under 30.


The calculation of the aggregate PE ratio for the ten largest holding of VDE:

The most straight forward way to calculate the PE ratio of a group of firms when some firms have negative earnings involves dividing the sum of the market values of the firms by the sum of the earnings of the firms.   This calculation is presented below.
  

Company
Market Cap
Earnings
Exxon Mobil Corp
338.8
10.2
Chevron Corp
209.1
2.9
Schlumberger Ltd
91.0
-1.9
ConocoPhillips
55.5
-1.5
EOG Resources Inc
52.6
-0.6
Occidental Petroleum Corp
46.9
-0.5
Phillips 66
43.5
1.6
Kinder Morgan Inc P
44.1
0.7
Halliburton Co
35.8
-3.4
Valero Energy Corp
30.3
2.0
PE Ratio
Total
947.7
9.4
100.4


The aggregate PE ratio for the ten holdings is 100.4.

An alternative algebraic procedure can be used to obtain the PE ratio of a group of firms when some firms have negative earnings.

Go here for a discussion of this other method.

Comment on PE ratio reported here and PE ratios reported by CNBC:

On August 9, 2017 CNBC reported that VDE has a PE ratio of 3.23.   They appear to be taking a weighted average of the PE ratio for all stocks. THIS IS WRONG!  

PE ratios of firms with negative earnings are totally meaningless.   Look at Occidental Petroleum.  Its PE ratio of -87 would be even a larger negative number if it earnings increased slightly towards zero. 

An examination of the PE ratios of the holdings of VDE indicates that VDE is overvalued.   The PE ratio reported by CNBC is highly misleading.

Concluding Remark:   Oil prices at least as measured in dollars have rebounded from their trough.   However, earnings have not rebounded and PE ratios are high.   Why are energy stock valued so high compared to the earnings these firms are generating?   

Potential Reasons:

  • Interest rates are low and safe assets are earning very little.


  • Some oil stocks may be viewed as a safer bet than some tech stocks.


  • Financial analysts are not providing accurate information on the valuation of this sector and other sectors.


  • Investors may believe that an increase in oil prices will soon increase earnings.

  • Investors are betting that the FED will keep its expansionary monetary policy forever


The gist of this post is that the major players in the energy sector are not in good shape. Smaller firms in the ETF may be even worse off.   Investors appear to be flocking to ETFs without conducting a detailed examination of the holdings of the ETF.    I believe there is a market for software that will automatically provide a detailed evaluation of ETF holdings and risk.   More on this topic to follow.