Should You Follow Warren Buffett and Increase Exposure to the Energy Sector?

Though energy stocks have crushed the broader markets in the last year, companies part of this industry are highly cyclical.

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During Berkshire Hathaway’s (NYSE:BRK.A)(NYSE:BRK.B) annual general meeting held over the weekend, Warren Buffett disclosed the company increased its stake in energy giant Chevron (NYSE:CVX). At the end of Q1 of 2022, Chevron accounts for 7.7% of Berkshire’s investment portfolio, making it the fourth-largest holding.

At the end of 2021, Berkshire Hathaway held US$4.5 billion worth of Chevron stock and at the end of March 2022, this figure surged to almost US$30 billion. Chevron stock also rallied by 30% in Q1 due to higher oil prices.

In the last six months, the equity markets have been impacted by a range of macroeconomic issues that include the possibility of multiple interest rate hikes, overvalued tech stocks, surging inflation numbers, higher commodity prices, supply chain disruptions, and the ongoing war between Russia and Ukraine.

The S&P 500 is already down 13% year to date, while the tech-heavy Nasdaq Composite index re-entered bear market territory last week. Comparatively, the energy sector south of the border has gained 35% in the first four months of 2022.

Companies part of the energy sector have experienced a massive uptick in earnings, as crude oil prices recently touched multi-year highs. Due to a significant increase in cash flows, the energy sector in the U.S. offers investors a forward yield of 4.7% compared to the 1.5% yield of the S&P 500.

In addition to Chevron, the Oracle of Omaha also purchased shares of Occidental Petroleum worth US$7 billion, increasing his total position to US$10 billion in the company.

Berkshire’s top holding remains Apple followed by financial heavyweights such as Bank of America and American Express.

Chevron has a dividend yield of 3.63%

Valued at a market cap of US$307 billion, Chevron is one of the largest companies in the world. In Q1 of 2022, Chevron reported earnings of US$6.3 billion, or US$3.22 per share. Its adjusted earnings stood at US$6.5 billion, or US$3.36 per share.

It was the third consecutive quarter where Chevron reported a free cash flow of US$6 billion, allowing it to return US$4 billion to shareholders and further lower its debt.

Chevron offers investors a forward yield of 3.63%, and the company’s robust business model, strong balance sheet and low cost of production have allowed it to raise dividends for 36 consecutive years.

Should you invest in energy stocks?

While Warren Buffett has significantly increased exposure to the energy sector, investors should note that the industry is highly cyclical and capital intensive. For example, iShares S&P/TSX Capped Energy Index ETF (TSX:XEG) has gained 95% in the last year, easily crushing the broader indices. However, in the last 10 years, annual returns are below 1%.

Yes, energy stocks are poised to benefit from higher oil prices. However, in order to offset an inflationary environment, central banks are likely to hike interest rates, which, in turn, will result in higher debt payments and lower profit margins.

Further, if recession fears come true, there is a good chance for crude oil prices to trade lower in the upcoming months. Instead of adding oil producers to your portfolio, I believe it makes sense to look at midstream companies such as Enbridge and TC Energy that are relatively immune to fluctuations in commodity prices.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Bank of America is an advertising partner of The Ascent, a Motley Fool company. American Express is an advertising partner of The Ascent, a Motley Fool company. Fool contributor Aditya Raghunath has positions in ENBRIDGE INC. The Motley Fool recommends Apple, Berkshire Hathaway (B shares), and Enbridge.

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