Tuesday, May 10, 2011

Does Recent Oil Plunge Spell Opportunity to Invest in Chevron?

Stock in Chevron (NYSE: CVX), the second largest oil company, has taken it on the chin in the last few weeks -- falling 4.6% since the beginning of May. But Chevron is a very solid company and if the global economy keeps growing, it could be a great way to invest in that growth. Should you add it to your portfolio?

Chevron has operations around the world in petroleum, chemicals, mining, power generation and energy services. It explores for, develops and produces crude oil and natural gas; transports crude oil by international oil export pipelines; transports, stores and markets natural gas, and a runs a gas-to-liquids project. Chevron's so-called downstream operations refine crude oil into petroleum products and they market crude oil and refined products.

And Chevron has put in a solid financial performance. Its $217 billion in sales over the last year have been growing -- very slowly at a 0.67% five year compound annual growth rate while its net income of $20.7 billion has risen at a more robust 6.7% over the last five years.

But Chevron has been lagging its peers. It is growing more slowly than the industry -- its sub-1% sales growth compares unfavorably to the industry average of 7.5% over the last five years. five year average net profit margin of 8.3% is lower than the industry average of 11.1%. But the good news is that its five year average return on equity of 21.9% edges out the industry's 20.2%

Chevron's more recent financial performance has been respectable. Last month, it reported $6.21 billion in first quarter 2011 profit, or $3.09 a share up 36%, compared to $4.55 billion, or $2.27 a share, a year earlier. Its revenue climbed 25% to $60.34 billion and it beat analysts' estimates of $3 per share "mainly due to better-than-expected performance in its international exploration-and-production segment and higher oil price realizations," according to Dow Jones Newswires.

Should you buy on the recent dip? To make that decision, you might consider using the price-to-earnings-to-growth (PEG) ratio that compares a stock‚Äôs market valuation to its forecasted earnings growth. By that measure, if a stock trades at a PEG of 1.0 or lower, it is reasonably priced. Higher than that, and it looks overvalued.

Chevron's PEG of 3.45 -- based on a P/E of 10 on earnings expected to grow 2.9% to $13.14 in 2012 -- looks expensive to me. Of course, if the price of oil plummets, that bet will look even worse. That's because the more a trader has to set aside to control oil futures contracts, the less attractive that trade will look due to the higher risk.

So keep your eye on how much margin those oil traders are required to keep in their accounts -- if that figure rises far above the current $8,438, the price of oil could drop further. In the meantime, if you think Chevron can keep growing earnings at 36%, then its PEG is a mere 0.28. But if you think that growth will slow down to the 2.9% that analysts forecast, beware.

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