Exxon Mobil: Why the Stock Looks So Rosy

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Since peaking at $95 per share in 2007, Exxon Mobil (NYSE:XOM) has been in a consolidation range, and it has underperformed several of its peers in the integrated oil space. While there were exceptions such as BP (NYSE:BP), which suffered through the Gulf Oil spill, investors tended to favor its smaller yet less expensive peers such as Chevron (NYSE:CVX) and Conoco Phillips (NYSE:COP).

However, throughout this time frame, Exxon Mobil’s underperformance in both share price and in earnings growth was due in large part to long-term investments. Large investments in XTO energy and in the Arctic didn’t immediately generate earnings, and in fact, the former increased the company’s share count, thereby reducing earnings per share.

But while Exxon’s competitors have largely been focused on nearer-term growth, Exxon Mobil has looked far into the future, and now it appears as if this strategy is paying off. True, it isn’t yet generating earnings, but it is attracting new investment dollars — most notably from Warren Buffett’s Berkshire Hathaway (NYSE:BRKA), which has begun to accumulate shares while selling rival Conoco Phillips despite the latter company’s lower P/E ratio, higher dividend, and faster near-term growth.

This tells me that Exxon Mobil is the oil major to bet on longer term. That isn’t to say that the other oil majors aren’t solid investments — they are some of the least expensive stocks in the market, and they are extremely shareholder friendly. But while commonly used metrics suggest otherwise, Exxon Mobil is incredibly well positioned going forward to take advantage of growing global demand for energy.

It is following simple yet powerful strategies that convince me that it will be a solid investment going forward.

First, it is very conservative in making investments. Exxon Mobil makes very few investments, although when it does make an investment, it is large and it is geared toward the future. This is what the company did when it purchased XTO Energy, a huge natural gas company. Critics argued that Exxon Mobile didn’t pick the bottom in natural gas, but now with a bottom clearly in, the company’s natural gas exposure will start paying off. In 20 years, it won’t matter so much whether Exxon Mobil bought XTO Energy when natural gas was at $2.50 per MMbtu or at $4 per MMbtu. It is going to be accretive and secure the company’s dominance in the natural gas market.

Second, the money it doesn’t invest, it returns to shareholders. The company has the best track record in the industry of returning money to shareholders in the form of buybacks and dividends. Investors like to argue that Exxon Mobil’s peers are growing production at a faster rate. This may be true — for now, at least — but we can also point to the fact that Exxon Mobil is growing production on a per-share basis faster than its peers because of its share buyback program. Exxon Mobil will only make an investment if it is highly accretive to shareholders, otherwise it figures that the best investment is in its own shares, and at 13 times earnings, I agree.

Third, Exxon Mobil has an incredible balance sheet. Despite the fact that Exxon Mobil has the best credit rating awarded — AAA — it has just $23 billion in debt outstanding. That’s far less than what the company makes in a year. While some investors would prefer that the company borrowed more money in order to invest more aggressively, or even to buy back more stock, this conservative approach has been a winner for decades, and I suspect that it will continue to be a winner in the long run.

With Exxon Mobil shares trading just a hair below their all-time high, I think we may be at the point where the stock is finally breaking out. While it has traded above the 2007 $95 per share level off and on in the past several months, this strength has been met with skepticism that Exxon Mobil is growing too slowly and trading at too high an earnings multiple relative to its peer group. Once the breakout begins, I suspect that investors will start to look at the company differently, and they will finally appreciate the strategies — outlined above — that have made it so successful over such a long period of time.

Disclosure: Ben Kramer-Miller is long Exxon Mobil and Chevron.

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