ConocoPhillips Stock Does Look Cheap Right Now
Energy stock ConocoPhillips is being touted as a buy right now by JPMorgan because it has sold off so much this year. Whether the selling has stopped is what we need to decide.
You hear stocks being described as “cheap” quite often, although any time a stock loses value it can be called that. It’s usually not made all that clear why cheap is a good thing when it comes to stocks, as this is for the most part assumed by these people along with a lot of their audience.
This is a leftover from a strategy from the past involving the assumption that what goes down will eventually go back up. Although this was never all that good of a strategy, there was a time where investors would see cheap stocks and buy them a lot more than they do today. If you picked your spots, where the crowds headed, you could generate a positive return.
This approach is now pretty antiquated, even though it still lives on in the minds of some analysts, and quite a few are still swayed by this to some degree. It doesn’t do that well as a strategy anymore because there is less focus on cheapness and more on momentum than there used to be.
Investing requires us to use our minds to differentiate between various opportunities out there at any given time, and when it comes to cheapness, we’re going to need to think a lot more about this than just calling a stock cheap and assuming that this is somehow a good thing rather than a bad thing.
There is only one reason why this would ever work and it is because the cheapness stimulates demand for the stock. People see that it is cheap and want to buy it more, and want to buy it more than people want to sell it and are also willing to pay more for it over a period of time than it is selling at now. This is what we call upward movement with a stock and there are no other influencers ultimately besides supply and demand.
People get confused whenever they think that there are other factors involved, and one of these other factors is cheapness. The link between cheapness and the stock prices themselves, the mechanism of action in other words, isn’t really explained, and it is instead just assumed.
Some magical force in the universe that governs stocks simply steps in and runs the stock price up or down depending on what the effect is, and this includes so-called expensive stocks being moved downward by this mysterious force as well as cheap stocks being moved upward.
In any case, this invisible force just doesn’t work like it used to, but many people still cling to it, and it’s usually because they just don’t have any other way to understand what moves the prices of stocks.
This all arises from the assumption that we can predict stock prices in a way that can just ignore supply and demand, or at least make it subservient to our theory. If a stock is cheap, then demand will obviously increase because that’s just an assumption we make.
If we keep assuming this and don’t even care to measure the validity of our assumptions, they can endure for a long time indeed.
All the Bad Stocks are Cheap, and Many Cheap Stocks are Bad
Cheapness clearly and unequivocally indicates that demand for a stock is weak, and weak demand persisting does not lead to it increasing. We require another force, an opposite one in fact, to be brought to bear on the situation before we will see the situation reversing.
There are some cases where we can make a connection with a stock price declining and a reversal, which we call the oversold condition. Unlike the pure appeal of cheapness, this seeks to distinguish a cheap stock that is cheap because not enough people like it with one that they may have gone overboard with their dislike, where it actually does become too cheap and this becomes corrected.
There are two elements to this, and we always need both before we can say that cheapness is being corrected. The stock has to get cheaper and the market needs to also see it as being too cheap, and then put money behind this belief.
Saying that ConocoPhillips is a cheap stock is in itself not really meaningful, other than to caution us that we are going to need to be more careful with playing it. Successful investing requires that we manage both risk and return, and those who like cheap stocks need to realize that the risk/reward ratio generally is terrible at any random point in time, and we therefore need to weed out the terrible to find the ones that actually do have a promising ratio.
We do not want to put any real weight on the cheapness itself, whether that means assuming it will either go up or down from here based upon the cheapness. Stocks that become particularly cheap can have more potential to gain in some cases, but only in some, and in many others its potential on the downside can be greater.
ConocoPhillips has indeed become cheap, and we need to ask whether this is the good kind of cheap or the bad. A stock underperforming is normally a reason to sell and stay away, which is why this is not a desirable characteristic generally and we need some good reasons besides this to want to do something else besides short it.
There has certainly been stocks out there that have done worse and much worse over the last 5 years, but given that it has lost 37% since the summer of 2014 while the S&P has gained 50% during this time does indicate just how cheap it has become relative to the broad market.
It is also down 15% year to date compared to the market being up 19%. If started the year cheaper and has just gotten even cheaper as the year went on. Cheapness in itself is far from a virtue though.
Maybe we have hit the bottom here, but you can’t just look at a bad stock and pick bottoms just because it is bad. It has to get better and we have to have good reasons to think that this has all changed before we can claim it has and not just be trying to pin the tail on the donkey. During declines, all of our tails are going to miss and we’ll be down a lot of money for our trouble.
ConocoPhillips Stock is Not a Reliable Bottom Play
If someone was hoping to make bad investments instead of good ones, picking cheap stocks just because they are cheap is the best way to do it. ConocoPhillips has even put together some really good teases along the way, when it looked like it was going to finally move up, just to see it resume its normal course downward.
The single biggest reason why ConocoPhillips is not a good stock play right now is all these failed comebacks. It is challenging enough to pick a bottom with a loser, but with all these false starts, we really don’t have anything reliable at all to hang our hat on until too far in the move to be tempted.
We normally need to see some good signs of a reversal to play it confidently enough, and if what may otherwise be a good sign fails time and again, picking the bottom will be made far more difficult, and difficult enough that we should not even think of attempting this.
There are many fish in this sea and many that do not have this combination of bearishness and unpredictability. Even if it turns out that this stock rallies from here to the extent where it makes back all its losses over the past 5 years, this still doesn’t mean it was a good trade, because the odds of this are too low. Over time, what is basically a random entry like this will not only underperform the market, it will lose money.
The reason is that, among all the potential entries, one will work but the chances of you guessing which one is way too low. We need to be right more than we are wrong with investing, and being wrong a lot more just doesn’t cut it.
ConocoPhillips stock is so terrible that we cannot even rely on the price of oil going up to prop it up and even keep it from going down more. One of the biggest characteristics of oil stocks is that their progress is very much linked to oil prices rising, and with all of the new supply on the market now as well as all those new reserves, that alone should steer us well away from this sector.
When your stock even goes down when oil goes up, and WTI is up 19% so far this year, in comparison with ConocoPhillips stock losing 15%, not even better fundamentals can help it.
The fact that a lot of companies in the sector are losing money right now may be due in part from the increased amount of investor activism we are seeing, with a lot of the focus being on climate change. It is companies like this that they shake their fists at the most. This is only expected to increase and directly damages the price of a stock independent of anything else. This might be the biggest reasons why we should avoid this sector and be very careful when we don’t.
ConocoPhillips can at least boast that their stock has outperformed the sector over the last 12 months, only being down 25% as opposed to the sector being off by 50%, but this is like the injured comparing wounds. The only reasonable conclusion here is that we probably will want to stay well away of the sector as well as this stock.
CEO Ryan Lance boasts about how focused his company is on dividends and their “shareholder first” approach. Gaining 3% in dividends while losing 15% of the value of your stock, where shareholders are down 12% versus the money under the mattress strategy, is nothing to be proud of.
Phil Gresh, the JPMorgan analyst that is touting this stock, calls ConocoPhillips “the best house in a bad neighborhood.” This leaves open the question of why we should be interested at all in bad neighborhoods, or whether this is a wise thing. Being the best-looking shack on the street doesn’t count for all that much.
Editor, MarketReview.com
Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.
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