LB Thinking Podcast: Do energy and material sectors hold promise?

Welcome to Left Brain Thinking, where creative investment ideas meet logical analysis. That's the hallmark of Left Brain Investment Research, where the analysts are looking for growth companies with the potential to double in 2 to 3 years and high-yield bonds with the potential for dramatic price appreciation. And today we're looking at areas of strength in this challenging market with Brian Dress, Director of Research at Left Brain Investment Research. But before we get Brian's take, I want to remind you that Left Brain has a lot of ideas. You can find them in the Jarvis newsletter, which highlights the insights gained from the weekly outputs of Jarvis, the firm's proprietary research system. But they also have started doing a weekly discussion of market events that accompanies the newsletter. That's available on YouTube where you can search Left Brain Investment Research, or you can just get everything by going to the leftbrainir.com website. Looking for a link there to the YouTube, information on the Jarvis newsletter, and more. By the way, the firm is on Twitter too, @LeftBrainIR. Brian Dress, great to chat with you again.

Hi, Chuck, great to be with you and the Left Brain Thinkers.

Brian, this market has been challenging, and Nolan and all the Left Brain guys, we're typically talking stocks and not ETFs. But one of the things that you do, and it's explained really well in the latest Jarvis newsletter, is that you use ETFs to kind of help you see what is trending. In other words, you don't necessarily want to say this is a hot stock if it's in a really cold sector. So you're looking at a lot of different ETFs and they're helping to guide you. Explain what they're pointing you towards right now and why.

As you said, Chuck, we always follow about 300 ETFs on a weekly basis in Jarvis, and we're looking for areas of strength and areas of weakness in the markets, because at the end of the day, we're active managers. And so we want to be deploying capital to where things are working right now. It seems like the fundamentals don't matter as much as sort of positioning in the market. And having done some of these analyses with the ETFs, we're seeing a lot of, a lot of strength in a lot of the more value-oriented sectors that have been downtrodden over the last few years. And that's mainly energy. Materials, healthcare, financials, and a few selected retail stocks. So it's definitely taking our research in a different direction than it has been for the last few years, which has been mostly technology and growth-oriented.

Obviously we've got a market that's pretty frothy right now. Are these trends things that you're watching? Are they things that are investable at this point? And if so, are you able to find the kind of growth you guys look for at Left Brain in these sectors.

I'll just go ahead and tell you right now, we're not seeing the same type of growth as we saw in the type of stocks that we really favored over the last few years. But that's okay. What we are looking for and the common thread between now and the stocks we liked previously is acceleration, albeit from a lower base. Some of these value-oriented stocks that we're looking at are accelerating revenues, earnings, and the like. And so we like those type of stocks. So that's where we're definitely focused, is these more value-oriented sectors. But we need to find some acceleration in earnings, remembering that price is a function of both earnings and multiple. What we like about the value sectors now is not only do we see some level of growth in earnings, but we think there's an opportunity for multiple expansion, which we just don't see sort of in the growth-oriented sectors.

So it's pointing you towards energy and materials. But even there, you gotta drill down, pun intended, I guess, with energy companies to find the right stocks. So as you're looking at the ETFs, you're saying these are the areas that are moving where I feel I can find the right thing. You're looking at the broad market and seeing fewer and fewer opportunities. Is it changing at all, your opportunity set? In other words, are you looking much more at what we would consider relative growth than absolute growth? Where you're saying I'll settle for a little something less, but I still feel confident in the trend, or it's still got to hit all the numbers?

No, you're right. We can't have the same standards as we had before. You know, we're looking at something different. We're looking at companies that are more evaluated on their earnings than are evaluated on sales growth. A quick data point out of Jarvis from last week. And as you mentioned, energy is really a big focus for us right now. 14 of our top 25 stocks last week in Jarvis were energy-related. So the signal is very strong there, but they're not all created equal, as you sort of alluded to. We like a few segments of the energy sector. We've been liking pipelines for a while, opportunities for quite a bit of income and dividends there. Not as much consideration of the, the price of oil in terms of how those pipeline companies do. So we like pipelines, but we started to branch out a bit as well in the energy sector. We like integrated energy companies, the large ones that you know the ConocoPhillips and Chevrons of the world. But we're actually starting to drill down a little bit deeper into E&P exploration and production type of companies. And what we see there, again, we use the ETFs as a tool to sort of direct our research, but then we dig down deeper because we're micro-oriented analysts at the end of the day. We think these E&P companies have really strong balance sheets, and there's a few reasons for that. Higher oil prices, they're not really spending a ton of money on CapEx looking for new discoveries. So from a balance sheet perspective, that's really solid. And then because of this and the higher oil prices, these companies are returning quite a bit more cash flow. And so what we see here is a capital return story developing. So owners of EMP shares can expect higher dividends and a lot of stock buybacks going forward, in our opinion.

Is there a poster child within the exploration and production area for you? I mean, as you pointed out, 14 of your top 25 stocks are currently energy-related, but that's oil services, that's, that's big oil, etc. Is there something specific since you like ENP?

One name I would throw out there is Hess. That has some ENP exposure. That's one we mentioned in our newsletter last week, so that's one we would mention. And then since you mentioned that, you know, not everything's created equal. We don't like everything in this, in the space. Oil services is one part of the energy sector we don't like. As I said before, reading a lot of these conference calls from these E&P companies, the common thread between almost all of them is they're not going to spend a lot of money on capital expenditures. We know that these oil service names like Transocean, Schlumberger, et cetera, have been some of our top 25 stocks over the last few weeks. But we think the story is not good for those companies long-term if these E&Ps continue to maintain minimal amounts of CapEx spending. We really think that'll flow through to the oil services in a negative way, because if there's no investment in drilling and that sort of thing, these oil services names, it's not going to follow through from a business point of view.

That's interesting because I know Schlumberger, which is ticker SLB, has been a stock that you guys have liked. So are you pulling away completely because you don't like the long-term prospects? Are you watching? Where are you? Because again, that's an interesting spot that you did like for a while.

I don't remember recall ever saying that, but yeah, we don't like oil services. It's just as simple as that. When we read through, not only from the ENPs, but also from the integrated, it's just a theme that just seems to be really prevalent throughout the industry. And so, you know, I think it's too much of a bank shot to play the oil service names. I think you're going to do a lot better looking for that direct exposure from the companies that are actually bringing oil out of the ground, not those that are servicing them.

Let's carry this over since we are talking about oil and energy. What does this do for pipeline companies?

We still like pipelines. Like I said, pipelines don't depend necessarily on the price of oil, but they do benefit from a higher price of oil. These companies have fixed-price contracts with companies that are moving oil throughout the country, but they also have to renegotiate these contracts on a periodic basis. So when they go back to renegotiate and oil's trading in the 80s, That's definitely a boon for them. So we like the pipelines. We like the pipelines before we like the integrated and the ENPs. So that story is still intact for us.

Brian, really interesting. And with the areas that you like and the concentration that you were talking about on the top 25 list, does that make you doubly picky? Does that mean that you don't want to go to too many picks in one area? Or if they're all passing the scale, you'll tilt the portfolio towards them because those are the best ideas of Jarvis. And if Jarvis isn't diversifying, neither are you.

Well, let's put it this way. Oil makes up about 3% of the S&P right now. Historically, it's somewhere between 6 and 8%. So we think there's got to be something that changes to bring that back into balance. So from our point of view, and as you said, we do like concentration. We're going to be looking to be concentrated more in energy, trying to play that maneuver from 3% back toward that more historical 6 to 8% of the S&P. And so in order for that to occur, realistically, we believe these stocks will do well. So we're orienting and tilting portfolios to be overweight energy. No question.

Brian, really interesting. Thanks so much for talking about it.

Thanks, Chuck. Been great to be with you again.

Left Brain Thinking is a joint production of Left Brain Investment Research and Money Life with Chuck Jaffe. Our conversations are not personalized investment recommendations. But are designed to engage your brain. Please do your diligence before making any financial transaction. I'm your host, Chuck Jaffe, and you can learn more about my weekday podcast at moneylifeshow.com. Thanks to my guest, Brian Dress, Director of Research at Left Brain Investment Research. To get more insights from Brian and the Left Brain team, sign up for the weekly Jarvis newsletter and check out Left Brain's new YouTube channel by heading over to leftbrainir.com. The firm also has a mutual fund, which you can learn about at leftbrainfunds.com and is on Twitter @LeftBrainIR. Left Brain Thinking is available every other Wednesday. Subscribe via your favorite podcast app. And until we don our left brain thinking caps again, happy investing, everybody.