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Best Values in Oil and Gas

Fri, 12/17/2010 - 09:41 by Rex Moore

Study after study has shown that stocks with low price-to-earnings multiples significantly outperform high P/E stocks. Research from my favorite investing guru, NYU professor Aswath Damodaran, pegged the outperformance at anywhere from 9% to 12% per year, depending on the study period. That's big money we're talking about.

But you already know that you can't just go out and buy the stocks with the lowest multiples. Companies can trade at dirt cheap prices for a number of dire reasons, including low growth prospects, skepticism about earnings, or high risk of bankruptcy.

These dangerous stocks can quickly crater. Buy too many of them, and you'll increase yourown risk of bankruptcy!

Thus, for a company to be truly undervalued, Damodaran says in his book Investment Fables: "You need to get a mismatch: a low price-to-earnings ratio without the stigma of high risk or poor growth."

Of course, you're unlikely to find any high-growth, low-P/E companies out there. But Damodaran suggests setting a reasonable minimum threshold for earnings growth, such as 5%. There are also various ways to minimize risk, including staying away from volatile stocks or companies with dangerous balance sheets.

The screen's the thing
We're looking for companies with low price-to-earnings multiples, but also a relatively low amount of risk, and the potential for reasonable growth. Our screen today will cover the best value plays in the oil and gas industry.

There are an 197 such companies with market caps topping $500 million on major U.S. exchanges. They have an average forward P/E of 26.1. Here are my parameters:

  1. To stay away from bankruptcy risk, I used Damodaran's suggestion and only considered companies with total debt less than 60% of capital.
  2. In hopes of capturing a reasonable amount of growth, I looked at Capital IQ's long-term estimates, and kept only companies expected to grow EPS at 5% annually or better over the next five years. Furthermore, I required at least 5% annualized growth over the past five years.

Of the 25 companies passing the screen, here are the 10 with the lowest forward price-to-earnings multiples:

Company

Market Cap
(in millions)

Forward P/E

Debt-to-Capital

Estimated EPS
Growth

Chevron (NYSE: CVX)

$175,142

9.3

9%

9%

Alliance Resource Partners(Nasdaq: ARLP)

$2,347

9.3

50%

10%

Southern Union (NYSE: SUG)

$3,063

12.5

60%

8%

Arch Coal (NYSE: ACI)

$5,217

13.0

43%

9%

Hess

$24,499

13.5

26%

12%

Cimarex Energy

$7,262

13.7

12%

16%

Peabody Energy (NYSE: BTU)

$16,712

14.2

38%

6%

Alpha Natural Resources

$6,366

14.5

23%

10%

World Fuel Services (NYSE: INT)

$2,239

14.6

2%

8%

Sunoco Logistics Partners(NYSE: SXL)

$2,738

15.3

57%

6%

Source: Capital IQ, a division of Standard & Poor's.

There are lots of good research candidates here. To further stack the odds on your side, Damodaran says you can eliminate any companies that have restated earnings, or had more than two large restructuring charges over the past five years. And if volatile swings in price cause you to lose sleep, consider only companies with betas less than one.

© 2010 UCLICK L.L.C.

Last edited by Prince damin on Fri, 12/17/2010 - 09:41 | Write to author: Rex Moore | Bookmark and Share