Outperform the TSX With Energy Stocks?!

Energy stocks in general have been punished severely. Even the experts in the sector got whipsawed. Some of the top ideas selected by the experts have been down as much as 50% in the last 12 months! This just shows how challenging it is to pick a bottom on energy companies, which operate in a cyclical industry.

Many energy stocks saw meaningful gains on Friday. If there’s one reason to explain the phenomenon, it’s the fact that the energy sector is seriously undervalued, and lots of bargains are up for grabs. Another reason for the pop in oil stocks is that the WTI oil price is above US$62 per barrel, which is much higher than the low of US$30 back in early 2016.

Energy stock gains on Friday

The stocks of Husky Energy Inc. (TSX:HSE), Cenovus Energy Inc. (TSX:CVE)(NYSE:CVE), Cardinal Energy Ltd. (TSX:CJ), and Surge Energy Inc. (TSX:SGY) all popped +4%. Whitecap Resources Inc. (TSX:WCP), Torc Oil and Gas Ltd. (TSX:TOG), and Spartan Energy Corp. (TSX:SPE) were up +3%.

Here are some oil and gas stocks that climbed even higher on the day: Peyto Exploration & Development Corp. (TSX:PEY) was up +5%, Bonavista Energy Corporation (TSX:BNP) was up 9.5%, and Birchcliff Energy Ltd. (TSX:BIR) was up nearly 8%.

Here’s how cheap the energy stocks are

At the recent quotations, Husky Energy trades roughly at its book value, Cenovus Energy trades at a discount of ~30% from its book value, Surge Energy trades at a discount of ~40%, Whitecap Resources trades roughly at its book value, Torc Oil and Gas trades at a discount of ~10%, and Spartan Energy trades at a discount of ~20%.

Peyto Exploration & Development trades roughly at its book value. Bonavista Energy trades at a discount of ~80%. Birchcliff Energy trades at a discount of ~45%.

stock market volatility

Extraordinary upside potential

Here’s a sense of how strong these stocks can appreciate.

An analyst who specializes in analyzing energy stocks gave Birchcliff Energy a 12-month target price of $9 per share and a three- to five-year target price of $15 per share. These are potential upsides of ~165% and ~341%, respectively, for a near-term and long-term investment in Birchcliff Energy based on its Friday’s market close price of $3.40 per share. Notably, the three- to five-year target assumes a bull market in energy will occur.

Thomson Reuters’s consensus 12-month target of Birchcliff Energy is $5.80 per share, which represents ~70% upside potential. So, the analysts are in agreement that there’s extraordinary upside potential in this small-cap stock.

Energy stocks can outperform the TSX

Energy stocks can surely outperform the TSX in a bull market in energy, hands over fists! The tricky part is knowing when it’ll happen. Investors may have to wait a year, or three, or five, or more.

So, I wouldn’t recommend betting the farm on energy stocks. However, since many energy stocks are dirt cheap, it can serve investors well by investing and allocating, say, 5% of their portfolios in quality energy stocks, which will outperform the TSX when the time comes.

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Fool contributor Kay Ng owns shares of Birchcliff, Peyto, and Spartan.