Want Cheap Stocks? Be Careful When It Comes To Energy!

| March 18, 2015 | 0 Comments

dreamingCheap Stocks And Big Profits: Anyone Can Dream!

Admit it.

You dream of investing in a small-cap energy stock before it hits pay dirt and shares explode to all-time highs.

Of course, you make a boatload of cash in the process.

I know, I know.  It’s fun to dream big.

But the fact is, getting rich off cheap stocks is difficult- especially when it comes to the energy industry.

And with the oil market the way it is right now, you have to be exceptionally careful when investing in cheap oil stocks.  Invest in the wrong company and you could find your portfolio demolished by an unexpected bankruptcy.

Now don’t get me wrong…

The enormous downturn in the price of oil is presenting investors with some outstanding opportunities in small-cap oilers.  Great companies are trading at ridiculously cheap levels right now.  You just have to navigate the oil and gas industry very carefully.

How do you avoid disaster while still giving yourself the opportunity to make it big?

Let’s find out…

Simple Rules For Investing In Cheap Energy Stocks

The oil rout of late 2014 and early 2015 sent shares of a lot of small- and mid-cap oil producers crashing to levels not seen since the financial crisis of 2008.

Stock of many operators is now trading below $10 a share, which is the threshold I’m using to describe “cheap” in today’s article.

It truly is a remarkable situation.

But if you’re looking to invest in oversold oil companies with the idea of catching a big rebound, you need a set of rules to guide your decision making process.

Here are some simple guidelines that will help steer you away from disaster:

  • Stay away from stocks in a downtrend – There’s a misconception amongst many cheap stock investors that at some point the worst “has to be over” for a particular company.

Maybe you’ve thought to yourself, “this stock is down so much over the past six months, it just can’t go any lower.”

That’s a very dangerous line of thinking.

Just remember, the only price at which a stock is 100% guaranteed not to go lower is…. $0.

How do you avoid throwing money down a hole?

Only consider investing in companies that have stopped trending downward.

While it’s not foolproof, if you focus on stocks that have started forming a sideways base or are trending higher, you’ll increase your odds of success.

But even if you follow this rule, you’ll still need to place a stop loss order below an important trend line or support level.  After all, a company can announce bearish news at any moment, which can throw the share price into another downtrend.

And whatever you do, don’t average down into losing positions.  This is a recipe for disaster when you’re dealing with cheap energy stocks in the current oil price environment!

  • Steer away from over-leveraged companies – Let’s face it… the oil and gas exploration industry is very capital intensive. Huge capital investments must be made before a drop of revenue is produced.

This makes oil and gas exploration one of the most debt-laden industries there is. 

Before you invest a penny in a cheap energy stock, make sure the company’s balance sheet isn’t turned upside down.  Be leery of companies with high debt relative to shareholder equity.

But that’s not all…

In the current oil price environment, you must be especially cognizant of the ratio between current assets and current liabilities, also known as the current ratio.

If liabilities are outpacing assets by a large margin (a working capital deficiency), the company could face liquidity problems.  Once that happens, the odds of bankruptcy start increasing quickly.

For more on analyzing the financial statements of small companies, check out this article.

There you have it…

While they may sound overly simplified, the two rules above go a long way towards weeding out cheap energy stocks you should avoid.

Once you have a list of companies that aren’t over-leveraged and aren’t stuck in a downtrend, you’ll have an excellent starting point for further research. 

Until Next Time,

Justin Bennett

BIO:  Justin Bennett is the head commodity research analyst at Commoditytradingresearch.com.  With over a decade of real world trading experience, he finds ways for you to consistently profit from movements in commodities and the companies producing them.  Sign up for our free reports and commodity newsletter at https://commoditytradingresearch.com/free-sign-up.

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Category: Energy, Natural Resource Stocks

About the Author ()

Justin Bennett is the editor of Commodity ETF Alert, an investment advisory focused on profiting from the ebb and flow of important commodities via ETFs. The commodity veteran and options specialist is also a regular contributor to the Dynamic Wealth Report. Every week, Justin shares his thoughts with our readers on a variety of commodity-related topics. Justin is also a frequent contributor to Commodity Trading Research’s free daily e-letter. And he’s the editor of another highly successful and popular investment advisory, the Options Profit Pipeline.