Here are 3 reasons why investors should warm up to energy stocks despite falling oil prices and growing short interest

• Investors should stick with energy stocks despite the recent decline in oil prices, according to DataTrek.
• The research firm offered three reasons to buy energy stocks, including upwards earning estimates and cheap valuations.
• "Apple and Microsoft, with 6.5% and 5.4% weighting int he S&P 500, are both larger" than the entire energy sector at 5.2%.

A recent price decline in oil prices has led some hedge funds to place short bets against energy stocks, but DataTrek Research co-founder Nicholas Colas doesn't think that's a good idea for a few reasons.

Instead, Colas thinks investors should be buying energy stocks despite the 11% decline in oil prices over the past month. Over the same time period, energy stocks are up about 1%, offering a rare divergence for a sector that tends to move in tandem with the price of crude.

"Moreover, XLE [energy sector ETF] is up 63% this year, by far the biggest winner of any sector," Colas said in a Wednesday note, alluding to the common thought that energy stocks may need to take a breather from here and consolidate their recent gains.

But attractive valuations, an increase in earnings estimates, and a fat dividend are three good reasons as to why investors should stick with the energy sector.

Attractive valuations

Even after their surge this year, the energy sector remains the cheapest group in the S&P 500, trading at just 10x future 12-month earnings, Colas noted. The S&P 500 as a whole currently trades at a 17.2x multiple. That's still a big discount for energy stocks.

"Put another way, Apple and Microsoft, with 6.5% and 5.4% weighting in the S&P 500, are both larger in terms of market cap than the entire energy sector at 5.2%," Colas said.

And even with such appealing valuations, earnings are still growing at a rapid clip for energy companies as they benefit from higher oil prices.

Earnings estimates are rising

"The problem with shorting energy stocks here is that Wall Street analysts' estimates for 2023 are still going up," Colas said.

An analysis of the eight largest energy companies in the sector saw an average upward revision to 2023 earnings estimates of 2% over the past month, while the mean 2023 price-to-earnings ratio for the same companies was just 7.3x.

"In our opinion, that is a tough setup for a short call. Generally speaking, you want to short/underweight expensive names when analysts' estimates are coming down. The energy sector fits neither of those criteria," Colas said.

A big dividend

Finally, the energy sector offers an attractive dividend yield of 4%, more than double the S&P 500's current dividend yield of 1.6%. That's especially attractive considering the broader macro backdrop of high inflation and potentially slowing economic growth.

"Lastly, energy remains a cheap portfolio hedge against a geopolitical event that causes an oil shock," Colas concluded.