The market seems to be in upheaval this year, yet the S&P
is only down 1% year to date. So what's going on?
#-ad_banner-#Simply put, we're seeing a rotation in the market
-- namely, from growth to value.
In hindsight, this development was easy to predict. We're in
the latter stages of an economic cycle, which tends to be
characterized by rising interest rates and inflation, combined
with lower corporate profit margins. This spells bad news for
momentum-based growth stocks, and we've seen the effects of that
play out in the past couple weeks.
In an effort to moderate investment risk during cycles like
this, investors tend to take a flight to safety, looking for
stocks with value, represented by good cash positions, low debt,
dividends, low price-earnings (P/E) ratios -- and, of course,
This raises the question: Where exactly should investors be
looking right now for safe, value-based stocks?
One of my favorite sectors right now is energy -- specifically
Oilfield service stocks are currently leading the pack in the
energy space, spurred on by strong earnings growth and low
valuations. Let's take a look at three of my favorite leaders in
Baker Hughes (NYSE:
is expanding internationally and currently operates in 90
countries. Just more than half its record $22.3 billion in
revenue last year came from North America. Margins are currently
expanding in Baker Hughes' Gulf of Mexico projects but
contracting in North American land projects, due to a supply glut
which is also affecting its competitors.
Those Gulf of Mexico projects helped Baker Hughes beat
first-quarter earnings expectations this week: Earnings per share
) came in at $0.84 a share, compared with analyst expectations of
$0.79 a share and up a solid 40% from the same quarter last
Such aggressive earnings growth is great to see in a
late-cycle stock -- especially one with a forward P/E as low as
BHI's 13.6. As a rule of thumb, undervalued stocks typically have
P/Es lower than their earnings growth rates.
But there's another important component to value stocks: debt.
I like to see a long-term debt-to-capitalization ratio below 40%.
Just as you don't want your personal debt to overwhelm your
monthly budget, investors don't want a corporation's debt
payments to strangle its ability to deploy cash where needed.
Baker Hughes has consistently held its long-term debt ratio below
20% for the past decade, but it hasn't increased its dividend
(currently yielding 0.9%) in quite a few years.
Standard & Poor's projects BHI's 2014 return on equity
(ROE) at 9.5%. That's significantly higher than in the past three
years, indicating strong corporate management. Wall Street must
agree, because institutions own 89% of this large-cap growth
is similar in size and scope to Baker Hughes, achieving a record
$29.4 billion in sales in 2013, with 52% of revenue coming from
North American operations.
Halliburton's fundamentals are very attractive, and the Street
expects EPS growth of nearly 20% or better for the next three
years. HAL's forward P/E is 12.1, on the low end of its
historical range, and the dividend yield is 1%. The 2013
long-term debt ratio is fair at 36%.
I'm happy with any stock with a low P/E, low debt, and annual
EPS growth of 15% or more. But Halliburton is also buying back
stock -- a bullish sign that almost always indicates a strong
balance sheet. Halliburton bought back $4.4 billion of its stock
last year and has about $1.7 billion left on its current
The stock recently retraced its highs from August 2011, then
rose further to the current range of $57 to just over $60. The
chart is extremely bullish, with no overhead price resistance --
but HAL's erratic year-to-year P/E swings makes setting a price
is also experiencing margin pressure due to overcapacity in North
America and weakness in natural gas production. To address this,
the company is shifting to higher-end technologies with higher
Schlumberger is also more focused on international business
than Halliburton and Baker Hughes, with only 31% of revenue
coming from North American operations.
Schlumberger's international business generated margins of
22.2% in 2013, a full 2.5 percentage points higher than its North
Like Baker Hughes, Schlumberger also beat earnings
expectations this week, with EPS coming in at $1.21, a penny
higher than forecast. SLB's forward P/E is 14.8, and its
long-term debt ratio is 20.8%.
The company has better international exposure than its rivals
and a higher dividend (currently yielding 1.6%). The downside is
that SLB's earnings growth is projected to be less spectacular,
between 10% and 19% over the next three years.
SLB shares broke past four-year price resistance around $94 on
March 25. The chart is bullish, with some long-term resistance at
How high could the stock climb? SLB reached a P/E of 25 or
higher in eight of the past 10 years. A P/E of 25 on expected
2014 EPS of $5.67 would put the stock price at $141.75.
That's better than 40% upside from today's price.
Risks to Consider:
The oversupply of oilfield services in North America could
last for several years, putting ongoing pressure on pricing and
profitability. In addition, oil and
can be volatile, capital spending decisions by customers can
change with a poor economy, and political risk can affect both
domestic and international energy markets. In addition,
Halliburton is still facing potential legal costs from the 2008
Deepwater Horizon incident. (My colleague Marshall Hargrave took
a look recently at
the company at the center of the Deepwater Horizon
Action to Take -->
Now is a good time to buy these three stocks, as oilfield
services stocks are on a distinct uptrend. Schlumberger
represents the best opportunity within oilfield services for
investors to maximize capital gains while minimizing risk. Baker
Hughes has strong earnings growth, a low P/E ratio and low debt
levels. The biggest caveat is three-year upside price resistance
near $80, because the stock could easily stop climbing for a
while at that point. In light of Halliburton's potential legal
liabilities, my suggestion is that only veteran traders invest in
Halliburton, using stop-loss orders to protect their capital.