Shock-Proof Your Portfolio With Undervalued Commodity Stocks

Commodities shape just about every aspect of our lives, from the cost of a tank of gas to the price of a gallon of milk. But instead of being subjected to the shocks of notoriously volatile commodity prices, smart investors find a way to soften the blow. Let me explain...

During the summer of 2008, when crude oil prices were near $150 a barrel, drivers felt a sting in their wallets. But while prices were high, companies like ExxonMobil (NYSE: XOM) raked in record profits. This example doesn't just apply to oil, either. Many other commodities traded near record highs during that time.

Take corn. Thanks to ethanol subsidies, the price of corn flour in Mexico nearly quadrupled in a matter of months in the summer of 2007. And while that country's poor rioted over the cost of corn tortillas, companies like Archer Daniels Midland (NYSE: ADM) made mounds of cash.

During the subprime crisis in the United States, people began stripping copper wiring from abandoned homes, hoping to capitalize on high copper prices. And when metals prices were near their highs in 2008, stories began to pop up about the increasing incidences of stealing manhole coverings to melt them down for their base value. This didn't just occur in one or two places -- it happened in cities around the world.

I suppose theft is one way to go about profiting from commodities, but might I suggest something a little safer (and legal) for investors -- simply buy commodity stocks, namely ones that will do well when prices are high.

With many commodity prices well off their highs, investors have a chance to pick up some world-class stocks on the cheap. And because of the boom-or-bust nature of commodities, many of them will be in a prime position when the time comes and prices rebound.

Today's Inside the Numbers focuses on finding these bargains.

Our research team screened for stocks meeting the following criteria: 

  • Energy, agriculture or metal stocks
  • Market cap greater than $500 million
  • PEG ratio below 1.0
  • Debt/Equity under 100%

Here's what turned up:

Notice any similarities in the table?

With a few exceptions, all of these stocks are involved in the oil business.

A few familiar names appear, such as Weatherford International (NYSE: WFT). The oil & gas equipment and services firm is held in legendary oilman T. Boone Pickens' hedge fund, BP Capital. Analysts expect the company to grow earnings +35% in the next five years, yet the stock is valued at a -38% discount to its growth potential (a PEG of 0.62).

Transocean (NYSE: RIG), Diamond Offshore (NYSE: DO), Noble (NYSE: NE), Ensco International (NYSE: ESV) and Pride International (NYSE: PDE) are offshore drillers that have rebounded after crude prices fell from record highs. But with crude at $80 a barrel (compared with its summer 2008 peak of $150) and a global recovery beginning to take hold, nearly all of these drillers could benefit from higher prices.

If you are an income investor, a company like Diamond Offshore could be an interesting candidate for your portfolio. While Transocean specializes in deepwater drilling, Diamond's niche is in mid-water drilling. Furthermore, Diamond has held back from building rigs and instead has focused on buying older rigs from some if its cash-starved competitors. This novel strategy insulated Diamond from a build-out glut in the industry and lent support to its generous 81% dividend payout ratio and 8.0% dividend yield. Going forward, Diamond will have to spend money to update its fleet, but it may be worth keeping an eye on to see if they can maintain their dividend strategies.

If you are an income investor who wants to learn about a class of special business entities set up specifically to shovel income to investors, click here to read how One of the Best Dividend Payers Ever Just Got Better.

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