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The Investing Lessons and Dangers That Lie Within the Cheapest Oil & Gas Stocks

Nearly three months ago, I wrote an article titled “Why You Should Proceed with Caution with the Cheapest Oil Stocks”.

In it, I had singled out five oil-related shares that had the lowest price-to-book (PB) ratios at that time. They were namely JES International Holdings Limited (SGX: EG0), Swiber Holdings Limited (SGX: AK3), Hoe Leong Corporation Ltd (SGX: H20), EMAS Offshore (SGX: UQ4), and Ezra Holdings Limited (SGX: 5DN).

I often revisit my older articles to see if I’ve gotten things wrong or right because they can serve as important lessons and help me hone my skill as an investor.

While a three month time-frame is far too short to come up with definitive conclusions, I thought the experience of the quintet since then would still contain useful lessons.

Checking back

Cheap shares can often make for desirable bargains. And those five shares, with their PB ratios of between 0.18 and 0.37 back then, did look really cheap.

But, I had warned (as the title of my earlier article suggests) that “bargain hunters ought to step in with their eyes wide open and be fully aware of the risks involved [with the quintet].”

That’s because those shares had problems – they had to deal with the low price of oil, an inability to produce cash flows from their businesses, and highly-leveraged balance sheets.

Oil companies' share price changes

Source: S&P Capital IQ

As it turns out, those problems have manifested themselves in terms of lower share prices; from 12 January 2015 (the date on which my earlier article was published) to today, four of the five shares have clocked painful losses of as much as 36%.

Lessons learnt

The most obvious lesson here is that cheap shares can go on to become even cheaper. That’s especially true when it comes to short-term time frames – the low valuations that the five shares carried back in January have offered scant protection to investors so far.

Another less obvious lesson here is that cheap shares can still become poor investments if their businesses deteriorate or fail to improve. I had mentioned above that a lack of cash flow and high leverage were weighing down the businesses of those five shares.

Oil companies' business changes

Source: S&P Capital IQ

You can see from the table above that there hasn’t been any big improvements in their business fundamentals over the past three months; most of them still can’t produce operating cash flows and their balance sheets are still heavily leveraged.

There’s one more lesson I have and it’s tangentially related to the one just above. The lesson is that improvements in a share’s business may take time. (There’s a chance that the five oil shares’ business can improve in the future!). Consequently, investors must also have patience with the investments they make as it takes time to right a ship.

A Fool’s take

At the moment, the oil & gas industry is an area which may throw up lots of shares which look cheap on a statistical basis. But, that doesn’t mean they’d necessarily be bargains.

Or, even if they do prove to be long-term bargains, you’d better be prepared to see some sickening drops in the interim before things get better.

For more investing analyses and important updates about the stock market, sign up to The Motley Fool Singapore's free weekly investing newsletter, Take Stock Singapore. Written by David Kuo, it can help you grow your wealth in the years ahead.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.