Simple Rules For Investing In Cheap Energy Stocks（ZT）

青影

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.

zhao

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