At its core, investing is all about risk versus reward. In other words, all investments carry a degree of risk and it is the investor’s mission to judge whether the potential reward is sufficient given the level of risk.
As such, a company or sector can be viewed as very high risk but, so long as the potential rewards remain relatively appealing, investing in it could prove to be a sound move. Therefore, the resources sector could turn out to be a very profitable space in which to invest – especially since it appears to be very unpopular among most investors at the present time.
Evidence of its unpopularity can be seen in the share price performance of oil major Tullow Oil (LSE: TLW). Its shares have slumped by 57% in the last year, although the company’s move into a loss-making position in the most recent financial year is a key reason for this. Looking ahead, Tullow Oil is expected to return to profitability in the current year and, with additional production due to come onstream part way through next year, the company’s earnings are forecast to rise by 422% in 2016.
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Certainly, there is a risk that Tullow Oil fails to meet its current forecasts or that they are downgraded between now and the end of 2016. However, with it trading on a price to earnings growth (PEG) ratio of just 0.1, there appears to be a sufficiently wide margin of safety on offer which makes the risk/reward opportunity seem favourable.
Similarly, Premier Oil (LSE: PMO) has also endured a disappointing period, with it too slipping into having a red bottom line. This was mainly due to write downs in the value of its asset base and, realistically, a persistently low oil price may cause further pain in this space. And, with the company due to make a further loss in the current year, its shares could come under additional pressure even after having fallen by 70% in the last year.
However, Premier Oil is forecast to return to profitability next year, with its pretax profit due to hit £37m. Although this would be just over 10% of its 2012 level, it would represent a move in the right direction and it has the potential to cause investor sentiment in the stock to improve. And, like Tullow Oil, Premier Oil’s valuation indicates that its risk/reward ratio is relatively favourable, with the company having a price to book value (P/B) ratio of only 0.3.
Also falling heavily in the last year is US-focused Empyrean Energy (LSE: EME), with the company’s shares trading 64% lower than they were at the start of the year. That’s despite the company being a profitable entity in financial year 2015 and being forecast to remain so in the current year, too.
Furthermore, Empyrean reported a significant rise in reserves at its main Sugarloaf asset in Texas (in which it has a 3% working interest), with proven reserves increasing by 13.8% and probable reserves increasing by 9.8%. Despite this, investor sentiment has remained weak towards the stock and Empyrean now trades on a price to earnings (P/E) ratio of only 9.9, which indicates that there could be upside potential.
Certainly, Empyrean could be viewed as a risky investment due to its size and the volatility which is likely to remain a feature of the oil sector in the medium term. However, for less risk averse investors it could be worth a closer look.
