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Ever since the war in Iran began on Feb. 28, a chain of events has showcased a tale of two outcomes. Iran closed the Strait of Hormuz, the crude oil supply dropped, and energy prices surged.
On one end, there's the pain that people have been feeling at the gas pump. On the other, there are energy companies positioned for record profits.
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In true Wall Street fashion, the allure of profits caused investors to pour money into energy stocks, making it the best-performing sector through early May this year. The S&P 500's energy sector is up 31%, well ahead of second- and third-place materials and industrials (up around 11% each).
Considering the sector's momentum (and no end to the war in Iran in sight), is it a no-brainer to invest in the Vanguard Energy ETF (NYSEMKT: VDE) to capitalize on it?
VDE is intended to give you broad exposure to the energy sector, covering everything from production and transportation to services, equipment, coal, and more. It holds 106 stocks, but it's very top-heavy. Its top three holdings -- ExxonMobil (22.68%), Chevron (14.97%), and ConocoPhillips (6.09%) -- account for over 43%.
As those three stocks perform, so does VDE. So far this year, that has worked out in its favor, with the ETF up 34% as of May 5.
If you're investing in the energy sector, owning a lot of ExxonMobil and Chevron isn't a bad option. They're both fully integrated, owning the whole pipeline from extraction from the ground to filling up your gas tank. That allows them to benefit from rising prices and have a bit of a crutch if (or when, rather) prices cool off.
ConocoPhillips isn't fully integrated; it only focuses on exploration and production. Its business is more sensitive to oil prices because its profits are directly tied to how much oil barrels cost, so its stock usually swings in that direction.
Those three companies have a significant influence on VDE, but the ETF also includes other notable companies such as Marathon Petroleum, Phillips 66, SLB (formerly Schlumberger), Kinder Morgan, and EOG Resources.
It can be easy to see a flourishing sector and want to chase the rally, but it's important to remember how cyclical the energy sector (and, by extension, VDE) is.
When there's a supply shock and prices rise, investors pour in to chase the higher profits, sending energy stocks up. At some point, high prices cause demand to slow (people drive less, airlines operate fewer routes, etc.), and profits aren't coming in as quickly. The slowdown leads investors to seek value elsewhere, driving energy stocks lower.
The cycles vary in time, and over time, the energy sector's trajectory has been upward. However, there's no denying there will be pullbacks along the way.
VDE is a good way to diversify your portfolio and complement the tech-heavy S&P 500 and Nasdaq Composite. The tech sector accounts for nearly a third of the S&P 500, while the energy sector accounts for only 4%. In the popular Nasdaq-100 index, tech accounts for over 64%, and energy is only 0.6%.
Needless to say, neither one of those is exactly the best way to get exposure to the energy sector. Investing in VDE gives you a chance to take advantage of cyclical highs in energy (like now), while also helping to hedge a bit against the tech sector.
Energy stocks also pay some of the more attractive dividends, so that usually translates to VDE. Its current yield (2.3%) is relatively low given its stock price growth this year, but it has averaged a 3.3% yield over the past five years.
If you invest in VDE, do so for diversification and the dividend, not because you're anticipating prices and profits to continue rising. Even if you're right, there's no knowing when the party ends, so be around for the long haul.
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Stefon Walters has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chevron and Kinder Morgan. The Motley Fool recommends ConocoPhillips, EOG Resources, and Phillips 66. The Motley Fool has a disclosure policy.
Is the Vanguard Energy ETF a No-Brainer Buy Right Now Due to Rising Energy Costs? was originally published by The Motley Fool