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Finding Best Value in Rebounding Energy Sector

This article was originally published on ETFTrends.com.

The energy sector is one of the better-performing groups in the S&P 500 this year, a trend reflected by an array of ETFs. For instance, the iShares U.S. Energy ETF (IYE) is higher by 5 percent year-to-date.

Energy is one of just four sectors sporting year-to-date gains. Some market observers believe the sector remains attractively valued. Data points confirm as much.

“At two times trailing price-to-book (P/B) the sector looks cheap relative to its own history. Since 1995 the large cap S&P Energy Sector Index has traded at an average of approximately 2.4 P/B,” said BlackRock.

The $1.03 billion IYE tracks the Dow Jones U.S. Oil & Gas Index and holds 68 stocks. Like other traditional cap-weighted energy ETFs, IYE devotes a significant portion of its lineup to Dow components Exxon Mobil Corp. (XOM) and Chevron Corp. (CVX), the two largest U.S. oil companies. Those stocks combine for 36% of the ETF's weight.

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More Value Energy Confirmation

Data support the notion that energy stocks are cheap relative to the broader market.

“Energy stocks look even cheaper relative to the broader market. The sector currently trades at just 0.57 times the P/B of the S&P 500,” according to BlackRock. “This compares favorably to the long-term average of 0.82 and the post-crisis average of 0.76. This is one reason energy stocks are currently over-represented in value indexes.”

Profitability and oil prices, two vital fundamental factors, also bode well for valuations on energy equities. Based on return on equity (ROE), the energy sector looks compelling.

“Today, with WTI crude at approximately $65 a barrel, the energy sector looks approximately 20% undervalued versus the broader market,” notes BlackRock. “A similar picture emerges when comparing current valuations to profitability. Measured by return-on-equity (ROE), profitability also explains about 20% of the variation in valuations. Based on this metric, energy companies appear about 10% too cheap.”

For more information on the oil market, visit our energy category.