Markets are generally fast at changing prices in light of new information. But being fast doesn’t always mean markets are right.
In fact, if you’re looking closely, markets seem to be wrong a lot of the time. Companies can and often do trade well beyond their future value, as anyone who invested in a .com company in the late 1990’s can attest.
That goes the other way as well. Some companies trade for a song, offering investors the chance to profit when unloved companies and sectors go from being unloved to the darlings of the market yet again.
In the energy sector, two sectors are getting hammered. Ultimately, the market will be shown as wrong for pricing coal and natural gas so cheaply.
Coal has been slammed since the start of the year, but the real blow to the coal sector came in March when the EPA proposed a new standard for carbon pollution from new power plants. The EPA wants to create a limit of 1,000 pounds of carbon dioxide (CO2) per megawatt of electricity produced.
Coal plants, on average, emit 1,768 pounds per megawatt, meaning the EPA’s change could effectively prevent new coal plants from coming online.
This means that coal, which currently accounts for almost half of America’s electricity production, would be gradually phased out in search of something else.
But here’s the funny thing about coal: The United States is swimming in the stuff.
That’s why the United States is called the Saudi Arabia of coal. We generate more electricity from coal than any other power source. We’ve even started to export our coal to countries that don’t mind dirty energy, namely China.
Thanks to the EPA, coal companies are cheap. Existing coal power plants still need to be supplied, and global energy demand continues to grow.
Firms like Peabody Energy (BTU) and Arch Coal (ACI) aren’t going away anytime soon, and trade at multiyear lows. They’re good buys near today’s prices.
Coal isn’t the only value. There’s a huge opportunity in natural gas too. Like coal, the United States has massive reserves, and we’re increasing supply at an incredible rate. In the past 10 years, we’ve been able to grow gas reserves so large that the price is currently at 10-year lows.
Investors looking to profit should stick with major producers like Apache Corp. (APA) and Devon Energy (DVN). Both have sold off during the current market rally, but have still managed to turn a profit while natural gas has been on the decline. In fact, both companies currently trade for single-digit PE ratios.
Coal and natural gas companies still have a bit further to fall. But investors who start buying now will likely see substantial upside once the market opinion shifts back the other way.
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