Canadian energy stocks can add fuel to a balanced portfolio

Investing in Canadian energy stocks could provide attractive long-term returns for your portfolio. As well, we recommend that most investors maintain some exposure to the Resources sector—and energy stocks—as part of a well-balanced portfolio.

The best energy stocks to invest in mainly include well-established, primarily dividend-paying stocks. We recommend spreading your money out across most if not all of the five main economic sectors, and downplay or avoid stocks in the broker/media limelight—and that includes the resources sector.

What to know before investing in Canadian energy stocks – 10 Tips

1. Look for oil and gas exploration companies that have cash flow from existing wells that is sufficient for, or at least contributes to, the development costs of additional wells.
2. Look at the market cap of oil and gas exploration companies versus the estimated value of the reserves they have in the ground. Sometimes, a company’s marketing efforts are so successful that they drive the stock up too high in relation to the size of their findings. We like an oil and gas exploration company’s market cap to be no more than half the value of the oil and gas in the ground.
3. Invest in Canadian energy stocks that use innovative new drilling and exploration techniques. Staying ahead of the curve will keep them in business.
4. Invest in oil and gas energy stocks that own diversified drilling sites in multiple geographic locations where exploration has been successful in the past.
5. Junior energy stocks are risky to invest in, because it’s relatively cheap and easy to launch a penny oil or other energy stock and sell stock to the public. So the junior energy promotion business attracts more than its share of unscrupulous operators and stock promoters.
6. Stay away from junior energy stocks operating in insecure and politically unstable regions like Nigeria and Kurdistan, or in countries with little respect for property rights and the rule of law, like Russia or Venezuela. Resource extraction is inherently a politically vulnerable business; you can’t move the oil wells to another country, and local citizens sometimes believe that a foreign resource company is robbing them of their birthright, even though they need the foreign company’s capital and expertise to get any value out of the ground.
7. The price of natural gas, like the price of oil, is highly volatile. It’s a bad idea to base investment decisions on predictions of future natural gas prices, because these predictions are simply not reliable.
8. Invest mostly in junior energy shares that operate in an area with geology that is similar to that of nearby producers. Look for favourable factors, like attractive geology, not hostile environments, like the high Arctic.
9. Invest in juniors with strong balance sheets and low debt and positive cash flow, preferably even when commodity prices are low. Even better, we like to see junior energy stocks that have cash flow from existing wells that is sufficient for, or at least contributes to, the development costs of another prospect.
10. Invest in well-financed juniors with no immediate need to sell shares at low prices, since that would dilute existing investors’ interests. The best juniors have a major partner who has agreed to pay for the drilling or other exploration or development, in exchange for an interest in the property.

Canadian energy stocks and long-term investing

Energy stocks have generally been below-average performers in recent years, and many investors are tempted to get out of the industry altogether. However, the energy segment can play a crucial role in your portfolio as a hedge against inflation. The low inflation rates of the past couple of decades deserve much of the blame for the poor performance of the sector. When they rebound, energy stocks could grow significantly for years to come.

We think investors will profit most—and with the least risk—by buying shares of well-established companies with strong business prospects. These are companies that have strong positions in a healthy industry. They also have strong management that will make the right moves to remain competitive in a changing marketplace.

A long-term record of dividends provides a measure of safety for investors. Dividends, after all, are much more stable than earnings. More important, dividends are impossible to fake—either the company has the cash to pay dividends or it doesn’t.

Well-established stocks have the asset size and the financial clout—including sound balance sheets and strong cash flow—to weather market downturns or changing industry conditions.

Are you currently holding Canadian energy stocks? How have they performed in your portfolio? Share your thoughts with us in the comments.