What are the dangers of buying cheap oil stock?


Quick Answer

The dangers of buying cheap oil stocks include market risk, default risk and inflation risk, as noted by Forbes. A stock represents an ownership share of a company, and its price fluctuates based on the financial performance of the associated company, as stated by CNN Money.

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Full Answer

Companies that have stocks associated with crude oil include Whiting Petroleum, Linn Energy, Denbury Resources, Patterson-UTI Energy, SM Energy Company, EP Energy Corporation and Freeport McMoran, as listed on the NASDAQ website. Each stock comes with its own market risk, or the risk that the stock price fluctuates based on general economic conditions. Interest rates, foreign exchange rates, commodity prices and equity prices are all market factors that influence the market risk of oil stocks, as listed by the Federal Reserve.

Default risk relates to the possibility that a company could go bankrupt and provide no return on the initial investment, as noted by Forbes. Oil companies in financial disarray can declare for bankruptcy. Under this legal protection, the companies can suspend all dividend payments to shareholders, as listed by About Money. Unless the stock price appreciates, the shareholder experiences a financial loss.

Inflation risk, or the risk that a stock provides a return that is less than the current inflation rate, is also adherent in oil stock investing, as listed by Forbes. Inflation rates vary periodically and represent the increase in the cost of goods. An oil stock that does not generate a return greater than the current inflation rate causes a financial loss since the cost of goods increases faster than the return on investment.

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