If you want to make the best energy stock investments, you need to read this advice
Most investors who are looking at energy stock investments would likely think of oil and gas first. But energy stocks can also include green energy, power from renewable resources like solar power, wind power, geothermal power and generating electricity from ocean waves, plus nuclear power.
Keep this in mind as you read our five tips for making the best picks while making energy stock investments.
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- Energy stock investments, like most resource stocks, tend to rise with inflation, even though they can be volatile
The resource sector is subject to wide and unpredictable swings in the prices it gets for its products. In the rising phase of the business cycle, when business is booming, resource demand expands faster than resource supply, so resource prices shoot up. This balloons profits at resource companies. When the economy slumps, resource prices fall, and this drags down resource profits and stock prices.
In addition to rising and falling with the business cycle, however, resource stocks have a history of rising along with long-term inflationary trends. This gives them a rare ability: they provide a hedge against inflation.
- Solar energy is a rapidly changing technology.
Solar power has attracted a lot of investment in recent years. That has quickly moved the technology forward. For example, advances in manufacturing techniques continue to steadily push down the prices of solar cells and solar panels. At the same time, alternatives to costly silicon, which is currently used in most solar cells, are emerging. However, technological advances add considerably to the risk of solar power companies that are focused on developing or making a single technology. That’s because they constantly risk being overtaken by competitors with a superior product.
- New technology plays a part in knowing how to invest in oil stocks
Oil is a key factor in a lot of industrial activity, as a raw material or as fuel for transportation. When oil prices shoot up, producers gain, but the economy suffers. This, though, has changed lately due to the development of vast oil and gas production from shale and other so-called “tight rock” formations.
The advent of “fracking” technology has opened up vast new potential oil sources. In the past, much of the world’s oil came from big underground pools, mainly concentrated in isolated areas such as the Mideast, where corrupt, volatile and backward governments were common.
- Some former oil royalty trusts are still worth investing in
Royalty trusts were investment products that profited from royalties on the sale of production from natural resource companies. Oil royalty trusts profited specifically from oil.
The 2011 tax change resulted in virtually all oil royalty trusts converting into conventional corporations. However, the basic tests we used to ferret out good investments in trusts, and to reject bad ones, still apply today to the former oil royalty trusts.
- Energy sector investments have a place in most well-diversified portfolios
Instead of a portfolio diversification approach like ours, some investors practice “sector rotation.” That’s where you try to predict which sectors will outperform other sectors. But trying to pick winning sectors—and stay out of other sectors—seldom works over long periods. That’s because you need to guess right three times to succeed.
You have to pick the top sectors, then pick the stocks that will rise within those sectors, then sell before the sector stumbles. It’s virtually impossible to consistently succeed at all three over long periods.
Resource and commodity stocks in general should make up only a limited portion of your portfolio—say less than 20% for a conservative investor or as much as 30% for an aggressive investor. And as part of that segment, energy stocks could make up, say, half of that total. The rest could hold fertilizer stocks, mining stocks and so on.
Have you ever made any poor decisions in your energy stock investments? What advice could you share on the topic?