Best Energy Stocks Picked by Hedge Funds

Hedge funds usually devote significant resources in researching stocks. In order to get a thorough understanding of a stock, they do many things that ordinary investors don’t have the time and resources. For example, equity analysts sometimes conduct on-site visits to companies they study and build up close relationships with management teams. As a result, hedge funds sometimes have access to borderline material non-public information and some hedge funds even trade on such information (see David Einhorn’s insider trading case). Hedge funds have an advantage over ordinary investors even when it comes to analyzing “public” information. Information cost time, money, and expertise to acquire. Hedge funds generally do a good job and ordinary investors can benefit simply by imitating their investments.

BP plc (ADR) (NYSE:BP)

In this article, we are going to take a closer look at a few energy stocks with the most number of hedge funds.

BP Plc (BP): This is the most popular energy stock among hedge funds tracked by us. At the end of last year, there were 57 hedge funds reported owning BP in their 13F portfolios, up from 53 hedge funds at the end of the third quarter. Doug Silverman’s Senator Investment Group initiated a brand new $100+ million of BP over the fourth quarter of 2011. Jim Simons, Bill Miller, and T. Boone Pickens were also bullish about BP (see T. Boone Pickens’ other energy picks).

BP is currently trading at a P/E ratio of 5.77, versus 19.24 for the average of its peers. The low multiple is mainly due to BP’s 2010 oil spill incident in Gulf of Mexico. The stock has been a bit risky. However, earlier this month, BP reached a settlement to compensate individuals and businesses impacted by the catastrophe for approximately $7.8 billion. We think BP is cheap enough to justify the remaining risk after the settlement. Analysts expect BP to earn $6.78 per share in 2012 and $7.11 per share in 2013. They also estimate BP’s earnings to grow at an average of 4% in the next couple of years. Therefore, BP’s P/E ratio for 2013 is about 6.6, versus 9.5 for Exxon Mobil Corp (XOM) and 8.4 for Chevron Corp (CVX). BP also has an attractive dividend yield of above 4%. Its low payout ratio also indicates that the company has the ability to further increase its dividend payments. So we think it is also a good option for dividend lovers.

El Paso Corp (EP): EP is the second most popular energy stock among hedge funds. There were 53 hedge funds with EP positions in their 13F portfolios at the end of 2011, up from 35 hedge funds at the end of the third quarter. The increased popularity is mainly because Kinder Morgan Inc (KMI) announced in October that it had signed an agreement to acquire EP for more than $20 billion. EP closed at $29.40 per share on Friday after the shareholders approved the merger. We have recommended EP in our previous article on February 17th when the stock was trading at $27.16. This was a classic example of a merger arbitrage play.

The third and fourth most popular energy stocks are Anadarko Petroleum Corp (APC) and Halliburton Company (HAL). Both stocks were held by 51 hedge funds at the end of last year. We have discussed APC in our previous article, so we are going to take a closer look at HAL.

HAL is also involved in the BP Gulf of Mexico incident. It is a bit risky stock as it is still exposed to punitive or civil damages. As a result, HAL is also trading at relatively low multiples. Its current P/E ratio is about 10.5, versus 26 for the average of its peers. HAL is expected to make $3.93 per share in 2012 and $4.56 per share in 2013. In the next couple of years, its earnings are estimated to grow at about 13% annually. So its P/E ratio for 2013 is about 7.7, versus 13.2 for its main competitor SLB. We think the best strategy for investors is to invest in BP and HAL at the same time to diversify the legal risks. Both stocks are trading at a big discount and one stock’s loss will be the other stock’s gain.

A few other popular energy stocks among hedge funds include XOM, Occidental Petroleum Corp (OXY), and William Companies Inc (WMB). All these stocks were held by at least 40 hedge funds at the end of last year. We believe XOM and OXY are undervalued relative to the market. Though XOM has slightly higher P/E ratio than BP, the stock is much less risky. It has also been increasing its dividend payouts for 29 consecutive years and its current dividend yield is 2.17%. OXY also has a relatively low forward P/E ratio of 10.45 and a double-digit expected growth rate. We are not very bullish about WMB though. The stock seems to be trading at a premium compared with its peers.