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After months of sluggish price action in the energy sector, most investors are avoiding some of the best companies in the sector, especially those in the oil industry. Whether news about current oil demand makes sense or not, investors need to think about the energy space as one of the most undervalued sectors of the market today.

Even Paul Tudor Jones said in a recent CNBC interview that commodities are extremely underowned today. Based on price movements in other commodities, investors can safely conclude that oil has the most upside potential given how low it has traded in recent quarters. However, this does not mean that all oil brands will immediately become a bargain.

There are those who hold oil, and there are those who help extract oil. Given how low production is today as a result of falling inflation, investors should pay attention to those countries that already own oil. That’s why Warren Buffett decided to buy up to 29% of the shares. Occidental Petroleum Co. New York Stock Exchange: OXY and why investors can count on giant Exxon Mobil Company. New York Stock Exchange: gold. To diversify the value chain, investors may then consider Select Energy Sector SPDR Fund NEW SIRKA: XLE.

Why Occidental Petroleum Earned Warren Buffett’s Seal of Approval

Investors need to first understand the two main pillars of Warren Buffett’s strategy so they can analyze why he chose Occidental Petroleum stock over all the options in the sector. His main goal is to find companies with high profitability and, secondarily, those that are trading at an attractive enough discount to be worth buying.

Occidental Petroleum’s profitability can be judged primarily by its gross margin, which reached 61.8% over the last 12 months. This high capital retention on each sale allows management to operate efficiently enough to maintain a net profit margin of 16.3%.

This is the basis of capital flows, but then management needs to take these profits and try to reinvest them into the business to activate the compounding wealth effect of the profitable business. The answer to this question can be found in its return on invested capital (ROIC), where Occidental Petroleum peaks at 17.7%.

When it comes to share price, underlying value is driven by the current price-to-book (P/B) multiple of 2.0x, compared to today’s average valuation for the rest of the energy sector of 3.7x. The combination of strong earnings and discounts may have prompted Raymond James analysts to set a $77 price target for the stock, implying upside potential of up to 51.3%.

How Exxon Mobil’s scale improves cyclical recovery

Now that oil prices are up more than 3% this week, investors can look to the industry’s biggest names to get their hands on their potential investment dollars. Given Exxon Mobil’s $523.6 billion market capitalization and its international sales, this is a stock to consider as the business cycle begins to shift upward.

As the US Federal Reserve (Fed) begins to cut interest rates again and other central banks around the world follow the same path, the business cycle of the world’s largest economies is likely to bottom out and return to growth again. Whenever this happens, oil demand follows, and that’s why Exxon Mobil is back in the game.

Recognizing that scale and reach will be key strengths in the upcoming oil market cycle, Scotiabank analysts have decided to upgrade their ratings to Outperform, coupled with a $145 per share price target for Exxon Mobil. This means the stock would need to rise 21.5% from where it is trading today.

Double-digit upside potential for such a large company is not common, so the fact that analysts are willing to set these targets with the stock already trading at 95% of its 52-week high reinforces the importance of these current analyst views.

How the XLE ETF Provides Protection from Oil Market Volatility

Exxon and Chevron company. New York Stock Exchange: CVX are the largest holdings of the Energy Select Sector SPDR Fund. However, there is also a sense of diversification across the oil value chain that continues to provide investors with upside opportunities beyond the ETF averages.

These features are making more institutional buyers justify expanding their positions in this ETF, especially from Hamilton Capital, which recently increased its holdings by 5.7% through November 2024. With this new distribution, the group’s net investment today rises to $297.5 million. giving investors another reason to pay attention to this sector.

Ultimately, when and if oil prices rise, it will be synonymous with higher inflation, and that’s where this ETF and its dividend come into play. Today, shareholders are offered a payout of $3.22 per share, which equates to an annual dividend yield of up to 3.4%, which is higher than today’s inflation rate.

Before you consider the Energy Select Sector SPDR Fund, you should hear this.

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