Using quant screening tools to assess potential stock investments in the oil & gas sector is in many respects as useful as drilling a well without looking at seismic data. The financials might tell some of the story but resource companies carry a great deal of information that’s not always easy to compare on a stock-for-stock basis. Items like asset values, resources and reserves, geography, tax, farm-outs and royalty issues add to the complexity. It’s not impossible to screen them – but it’s a complicated affair.
That’s not to say that there is anything lost in comparing oil & gas stocks on some metrics – if only to spark some ideas about where investor money is flowing and why. Share price momentum is among the most obvious tools in the box for tracking stocks that are in and out of favour, often because it is an indicator that is influenced by positive news flow. Not only that, but paring down the sector to find shares that are outperforming the general market – an indicator known as relative strength – could also point the way to those that are likely to keep rising.
Why relative strength works
Stocks that are displaying relatively strong price appreciation (or depreciation in the case of shorting) are magnets for momentum investors. And when that relative strength begins to weaken, the time to move on is likely to be fast approaching. The general consensus in support of momentum claims the phenomenon can be blamed on several factors, the most prominent of which is a type of behaviour known as the “disposition effect”. This relates to how both private and institutional investors react to news about a stock; the main point being that they tend to sell too quickly on good news to lock-in profits while selling too slowly on bad news in the hope of eventually breaking even.
In a seminal piece of research back in 1993, researchers Jegadeesh and Titman not only claimed that relative strength worked, they proved it with a strategy that was surprisingly straightforward. Their findings showed that selecting stocks based on their past 6-month returns and holding them for 6 months, realised a compounded excess return of 12.01% per year on average between 1965 and 1989.
Another explanatory factor behind momentum is a phenomenon called ‘post earnings announcement drift’ (Bernard and Thomas, 1990). This has been found to occur in the weeks and months following a company news story whereby the price drifts higher on good news, particularly when it is a surprise, rather than the market immediately pricing-in the full implication of the latest update.
1. The US
Over six months, the best relative strength seen in the oil & gas sector has been in AIM small-cap Magnolia Petroleum (LON:MAGP). With a target to close 2012 with interests in at least 100 wells, there has been no shortage of news from Magnolia this year. The company is focused on co-venturing on wells targeting the Bakken and Three Forks Sanish plays in North Dakota, US, and the Mississippi Lime, Woodford / Hunton formations in Oklahoma. It is also planning to start drilling its owns wells in Oklahoma. The shares have risen from 1.24p to over 4p in six months and brokers Hardman continue to rate the stock a strong buy.
2. Latin America
Elsewhere, Amerisur Resources (LON:AMER), which has operations in South America, saw its shares take off in late May as the first well in a six-well programme at its Platanillo field came good. Amerisur’s efforts to boost reserves at the Colombian field have been rewarded by two more well successes to date, which has doubled its share price to 43p in five months. The company capitalised on that gain with a $40m fundraising earlier this month, which is funding its bid commitments in the latest Colombian licensing round as well as more drilling work. Two more wells are scheduled to be drilled on Platanillo before the year is out.
3. The Falkland Islands
For Falkland Islands oil and gas analysts, Argos Resources (LON:ARG) has been the share showing the best strength among its peers in the region – rising 10p to 25p in the past three months. Argos is currently mid-way through a farm-out process for its North Falkland Basin licence but the company is upbeat on what its seismic data indicates. In particular, structures that look similar to the successful Sea Lion discovery made by Rockhopper Exploration in the same basin, have raised pulses. Meanwhile the arrival of Premier Oil to partner with Rockhopper and their plans for further exploration have all been welcomed by Argos.
At number eight on the list is Lansdowne Oil & Gas (LON:LOGP), a company whose shares doubled to over 60p during the summer on better than expected news from drilling work offshore Ireland. Lansdowne’s partner, Providence Resources (LON:PVR), hit the headlines with an oil find at Barryroe that was much larger than previously thought. Industry majors are apparently now being sounded out on helping to develop the field. For its part, Providence has been the strongest performing stock over one year (it is in 16th place on a six-month time frame).
5. The big one
Finally, the largest stock in the top 10 relative strength list over six months is Heritage Oil (LON:HOIL) which has been actively shifting its asset focus during 2012. In July the company agreed a deal that took it into Nigeria – a country where CEO Tony Buckingham has some experience. That was followed in August with the sale of a stake in its Miran block in Kurdistan to Genel in a cash and loan deal worth $450m. Overall, the shares have increased by more than 70p to around 194p in just over three months.
The common factor linking the strongest performing oil & gas stocks on a relative strength basis is positive news flow. Whether it’s successful drilling programmes, changes in strategy or, as with Argos Resources, a perception that events are stacking up in the stock’s favour. In that sense, tracking relative strength at least provides an idea of where the action is in the market. Of course, for oil & gas investors, the armoury of metrics and indicators is far broader – as is the risk range. Choosing between a stock that is building its reserves base versus one that is building profits is an individual choice that requires much deeper scrutiny of strategy. Either way, relative strength offers at least some glimpse of the stocks that are on the rise and could have further to go.
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