One thing that investors are often advised to do is to diversify. Not only does it mean that company-specific risk is reduced, it also means that the volatility of a portfolio is limited since a mix of companies from different sectors and which pursue different activities can combine to produce a more resilient and stable portfolio.
However, when it comes to diversifying as a business, it can be fraught with danger. For example, Centrica (LSE: CNA) may be thought of as a pure play domestic energy supplier by many of its investors. As a result, it is often viewed as a utility, with a relatively high yield and supposedly defensive prospects meaning that it is a mainstay for many retirement portfolios and for income seeking investors.
Centrica, though, has proven to be anything but a stable utility stock in the last year. For example, its share price has fallen by over 15% and a key reason for this is a falling oil and gas price that has hurt the prospects for its exploration and production arm. In fact, Centrica’s operating profit from its energy producing division was £1.3bn in 2013 and this represented around 49% of its total operating profit. By 2014, however, profit from the division had fallen by 44% to £737m as a lower gas price started to bite and the division now represents just 42% of Centrica’s total operating profit.
As a result of the decline in profitability, Centrica’s dividend has understandably been rebased, with a cut of 30% being announced earlier this year. Clearly, it remains an appealing income stock, with a yield of 4.5% still being among the highest on offer in the FTSE 100. However, its status as a reliable income stock has taken a big hit.
That’s not to say, though, that Centrica is worth avoiding. For investors who wish to have some access to the oil and gas production sector while also having the relative stability of a utility, Centrica is a great stock to buy at the present time. And, with it trading on a price to earnings (P/E) ratio of 14.8, it appears to offer good value for money, too.
However, there are a number of other stocks within the oil and gas sector that also offer great value and top notch yields. For example, oil services company, Petrofac (LSE: PFC), trades on a forward P/E ratio of just 8, since its bottom line is forecast to rise by a whopping 91% next year. Clearly, there is scope for its earnings to miss current guidance but, even if they do fall short, there appears to be a sufficient margin of safety to warrant purchase at the present time. And, with Petrofac yielding 4.7%, it remains a top-notch income stock, too.
Meanwhile, Cairn Energy (LSE: CNE) continues to struggle to generate improved investor sentiment, with its shares falling by 25% in the last year. Of course, its news flow has been very mixed of late, with its first half losses widening as a result of an impairment charge. This was disappointing for investors, since it was larger than expected and means that the company’s cash balance also fell to a lower level than anticipated. Still, Cairn clearly has long term potential, with it being given the green light this week to commence drilling operations in Senegal.
However, with losses mounting and an unclear future for the oil price, it seems wise to stick to profitable, dividend paying stocks such as Petrofac and Centrica. As for which is the better buy of those two companies, more risk averse investors may wish to buy Centrica due to its relative diversity, while for investors who can live with higher volatility, Petrofac seems to be the better option.