Buy Into Fossil Fuels

Energy-hungry consumers around the globe will be demanding fossil fuels. So be overweight in energy stocks--at least 12% of your equity.

Rich Karlgaard's recent column on energy and the Waxman-Markey carbon trading bill should be required reading for every high school and college kid. They should have to read it three times. Adults should have to prove they've read it before being allowed to vote. The column outlined the harsh reality of renewable energy. In this country 89% of electricity comes from three fuel sources: coal, natural gas and nuclear fission. That fraction won't change dramatically in the next decade. If you want your air conditioner to work in 2014, you'd better hope that more fossil fuel plants get built.

I'm riding down the road in a friend's electric Tesla Roadster. Sounds clean, doesn't it? But we are burning 49% coal, 21% natural gas, 20% nuclear and little else. Wind power? Zip! How will we run Teslas without fossil fuel? We won't. How will emerging markets, with a combined gdp already bigger than America's, grow without more fossil fuel? They won't.

Nuclear power might provide for our needs (and, if you believe in the global warming theory, protect our atmosphere). If the French can get 70% of their electric energy from nuclear safely and cleanly, then we can. But will we? Politically, it will be difficult. Many of the same people screaming that fossil fuel creates global warming are also adamantly against adding clean nuclear power. There are a lot of nuclear reactor applications pending in the U.S., but the permits will be few, and slow in coming.

That situation, and the fact that other energy-hungry countries will also be demanding fossil fuels, tells me you should be overweight in energy stocks. That means at least 12% of your equity in energy companies, and most of that in companies with a fossil fuel emphasis. Here's a hefty handful I like now.

I've recommended one energy stock in each of the last three months. But among U.S. firms producing petroleum and natural gas, four stand out: Apache ( APA - news - people ) (APA, 85), Chevron ( CVX - news - people ) (CVX, 70), Hess ( HES - news - people ) (HES, 51) and Marathon Oil ( MRO - news - people ) (MRO, 31). I like Apache's growth potential overseas and in natural gas, Chevron's mass and class, Hess' portfolio and projects, and Marathon's over-the-top cheapness. These are all high-quality firms with balance sheets and cash flows (in the sense of net income plus depreciation) quite able to withstand the volatility in energy prices.

Among my foreign favorites is Repsol YPF (REP, 24), a Spanish firm with a lot of assets in the New World. It has 2.3 billion oil- equivalent barrels of proven reserves, or about two barrels per share, and has daily production of a million barrels. A common criticism of Repsol is that much of its operations are in politically unstable parts of Latin America such as Argentina. I'm not as bothered as most investors by the politics of that continent. With increased wealth comes a bigger middle class and more political stability. That shift will help boost valuations. Repsol sells at book value, 40% of annual revenue and ten times likely 2009 earnings. It has a 4.8% dividend yield.

Even more disdained, and for the same reason, is the Colombian firm Ecopetrol (EC, 26). The mere thought of Colombia causes investors to envision drugs and death. But our government backs, and will continue to back, Colombia, and the Colombian government owns 90% of Ecopetrol. It produces about half what Repsol does but is more reserve rich per dollar of revenue, with 1.4 billion barrels. At ten times 2009 earnings and with a 4.8% dividend yield, it qualifies as a value investment.

I recommended Cameron International ( CMRN.OB - news - people ) (CAM, 35) last September at $43 as the market blew apart and rolled it over into my 2009 picks at 21. My original pick should pay off over time. Operating in 100 countries, Cameron makes specialty oilfield gear, much of it the kind of equipment (like blowout preventers and undersea machinery) that is hard to find elsewhere. The early 2009 collapse in oil prices hurt, but Cameron will be at the center of increased fossil fuel demand. It sells at 18 times depressed 2009 earnings but only 10 times my 2010 earnings estimate.

The French firm CGG Veritas (CGV, 21) collects and manages geophysical data (images of plausible drilling spots) and data on discovered oil reservoirs. If demand for fossil fuel grows, so will demand grow for CGG Veritas' services. This is an innovative technology firm as much as an energy-services firm. Yet it sells at 80% of book value, 80% of its $3.7 billion of annual revenue and 12 times my estimate of 2009 earnings.

Viva The V

If history repeats, the current V recovery is far from over. Expect another 20%-to-25% gain by January.

Viva the vrrooom! We're in the midst of a really big and steep V. As detailed in my Feb. 16 column, "Anticipate the V" (and updated in my May 25 column, "Blink and You'll Miss It"), big bear markets are almost always followed by big bull markets in a V-shape pattern. The steeper the descent, the steeper the ascent.

Most investors give too much credence to the theory that prices are rational; they presume that a market collapse must have been justified by serious economic trouble. As a result they presume that we can't have a big bull run after prices crash. History proves that presumption to be false.

This time the V is almost perfect--so far. As I write, the MSCI All-Country World index is exactly where it was on Sept. 29, 2008. From there to the Mar. 9 bottom was five months and ten days. From the bottom up to here is not quite seven months, a slightly lopsided V.

Note: The V works for the whole world stock market, not necessarily every country's. Any one market, including America's, can take on an odd shape. Always think globally first.

The fundamental force behind every V is always that the last phase of a bear market is driven completely by imploding panicky sentiment rather than the fundamentals people think they're thinking about. The sentiment implosion is a societal, psychological depressed-spring effect that makes the market bounce back as quickly and as far as it went down.

All the while people fret about sucker rallies and expected pullbacks, the V keeps its shape. I described that sequence for the 1930s in my May 25 column. Now take a look at the bear market bottom on Dec. 6, 1974. A year and five months later the stock market was almost exactly where it had been a year and five months before Dec. 6.

If history repeats, the current V recovery is far from over. If it keeps up for another six to nine months the global stock market will be 20% to 25% higher by Jan.1, 2010. We had a long (16 months) and deep (down 60%) bear market. Now we're getting a big, long bull run. Stay with it, with stocks like these.

Brazil's TAM ( TAM - news - people ) (TAM, 13) has 50% of Brazil's airline market. In developed markets airline stocks are dogs. In emerging markets they're growth stocks. tam should grow about 15% a year yet sells at only eight times my estimate of 2009 earnings, and at only 30% of annual revenue and 2.4 times cash flow (in the sense of net income plus depreciation).

Net Serviços de Comunicação ( NETC - news - people ) (NETC, 12) is Brazil's largest pay-TV provider, with 3 million customers. It also delivers Internet access and phone services. Net will grow with Brazil--and then some. It sells at 15 times my estimate of 2009 earnings.

With similar numbers of customers Canadian Shaw Communications ( SJR - news - people ) (SJR, 18) has a diversified communications business with cable tv, Internet, phone and satellite services. It should grow 12% a year and at 16 times earnings is relatively cheap for a company with low-risk growth. You get a 4.4% dividend yield.

Huaneng Power International ( HNP - news - people ) (HNP, 26) is China's largest nongovernmental electricity generator. It has 40 gigawatts of generating capacity in 17 wholly owned power plants, plus output from partially owned plants, and more power on the way. Power is central to China's growth and Huaneng is central to China's power. At 12 times 2009 earnings, 50% of annual revenue and 90% of book value it's cheap. Expect earnings growth of 15% a year.

Wynn Resorts ( WYNN - news - people ) (WYNN, 66) is among the world's biggest gaming destinations. In 2006 it earned $629 million on $1.4 billion in revenue. Now earnings are crunched for obvious recessionary reasons. In 2010 it should have well over $3 billion in revenue and by 2011 should be earning over $1.5 billion. But the company's market capitalization is $8 billion. You are, in other words, paying less than 6 times plausible 2011 earnings.

Grandma and Grandpa have the dough. With the recession ending they will do what they felt bad about not doing last Christmas--spoiling the heck out of the grandkids. Throughout this recession the toymaker Hasbro ( HAS - news - people ) (HAS, 27) kept the growth up with its endless stream of household names like G.I. Joe, Nerf balls, Play-Doh, Playskool, Transformers and Tonka. It's a classic consumer discretionary stock at a time when consumer discretionary stocks should lead the market. It's cheap at 13 times 2009 earnings and 1.1 times revenue. The yield is 2.9%.