05-05-2015, 05:43 AM
I was reducing my position in oil prior to the price collapse. I can't say this was due to special knowledge about the collapse in price. Rather I was getting more and more concerned about how to value these stocks. When doing my valuation calculations, the oil companies seemed to be outliers.
I am now thinking that oil companies should be treated as a hybrid of a normal company and a royalty trust. In a royalty trust, you are paid for the resources that extracted, which eventually go to zero. The payments can be viewed as return of capital. For an oil company, if the oil reserves are maintained, the company should be treated as a normal company; however, if the oil reserves decline, any earnings or dividends that correspond to this decline should be treated as return of capital.
For Chevron, the only oil company I still own, the oil reserves declined 1% last year. After adjusting for return of capital, Chevron is worth about $100 based on forward PE and $103 based on comparison with corporate bond yields.
I am now thinking that oil companies should be treated as a hybrid of a normal company and a royalty trust. In a royalty trust, you are paid for the resources that extracted, which eventually go to zero. The payments can be viewed as return of capital. For an oil company, if the oil reserves are maintained, the company should be treated as a normal company; however, if the oil reserves decline, any earnings or dividends that correspond to this decline should be treated as return of capital.
For Chevron, the only oil company I still own, the oil reserves declined 1% last year. After adjusting for return of capital, Chevron is worth about $100 based on forward PE and $103 based on comparison with corporate bond yields.