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number cruncher

What are we looking for?

In recognition of oil returning to $80 (U.S.) a barrel for the first time in a year, we're looking at how Canadian energy stocks have fared over the roller-coaster of the past 12 months.

Earlier in the week, we highlighted the best-performing stocks on the S&P/TSX energy subindex in that time. Today, we turn our attention to the laggards.

What did we find?

Seventeen stocks in the energy index generated price gains of less than 10 per cent in the past year - well below the 20-per-cent overall gain for the sector. Eight of those have actually lost ground, led by Savanna Energy Services Corp. and Precision Drilling Trust, which have slumped more than 40 per cent.

The laggard list is littered with energy-services companies, which were particularly hard-hit by the slump in oil and natural gas prices. While oil and gas producers slashed their capital spending budgets to preserve cash, that translated into a big drop in drilling in the oil patch, to the detriment of the drilling providers. Because oil and gas companies typically set their budgets late in the year, investors will be watching closely in the next couple of months to see whether producers feel bullish enough to ramp up drilling plans again.

Price-to-earnings, redux

Several readers pointed out that the previous column contained some fuzzy and contradictory information about price-to-earnings ratios for the Canadian energy sector.

In one breath, I said higher commodity prices should lead to improved earnings next year; in the next breath, I noted that the sector's P/E ratio based on forward 12-month earnings projections is a lofty 25, more than double its P/E based on the 12-month earnings. If profits are set to rise, shouldn't the P/E be smaller, because the "E" side of the equation is higher?

Absolutely. This discrepancy (and the confusion I caused by inadvertently pointing it out) illustrates the growing gap between investor optimism and the official forecasts of the analysts who track the individual energy stocks.

When commodity prices are rising, as they have been over the past few months, analysts tend to be slow in raising the commodity-price assumptions on which they base their earnings forecasts; they want to be sure the higher prices are sustainable before they adjust their calculations. They also tend to wait to see quarterly earnings reports before updating their earnings targets. The bulk of those quarterly numbers won't be out for a couple more weeks yet.

As a result, we have investors already pricing in a bullish outlook for profits (pushing up the "P" in the P/E) equation) before analysts have adjusted their own expectations (so, a steady "E"). The result: A bloated P/E of 25.

At that level, energy stocks look pretty expensive; we'll have to see whether analysts' earnings-outlook revisions justify investors' high hopes.

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