1 Great Energy Small Cap

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The Motley Fool's Hidden Gems newsletter has a variety of criteria for selecting and evaluating small-cap stocks. Fellow Fool Brian Stoffel speaks to the selection criteria here, so I'm going to focus on three metrics Hidden Gems analysts look at once they have selected a stock. Using three energy small caps, I will analyze insider holdings, free cash flow, and debt.

Insider holdings
Investors want to see company insiders buying up stock because it measures their faith in the business. For small- and mid-cap companies, it's nice to see ownership range from 5% to 45% of shares outstanding. I used the screener over at Motley Fool CAPS to pull the following numbers:

Company

2011

Hornbeck Offshore Services (NYS: HOS) 7.90%
BPZ Resources (NYS: BPZ) 17.60%
Global Industries
(NAS: GLBL)
12.10%

Source: Motley Fool CAPS.

All three stocks meet the insider ownership threshold I set, with BPZ Resources and Global Industries generating the best results. BPZ qualifies as a penny stock at The Motley Fool, which can be a turn-off to investors. But as fellow Fool Rich Duprey points out, despite the share price it still merits consideration.

Free cash flow
The next metric on the checklist is free cash flow, which is simply cash flow from operations minus capital expenditures, and it is usually a good indication of a company's profitability.
 

Company

2010

2009

2008

Hornbeck Offshore Services$69($90)$165
BPZ Resources($163)($120)($51)
Global Industries($72)($59)($387)

Source: Yahoo! Finance. Figures in millions.

Initially, most of these numbers look terrible. Hornbeck Offshore is the only company with positive cash flow in the last three years. A case like this requires further research. Breaking out capital expenditures might help clarify the FCF numbers.

Company

2010

2009

2008

Hornbeck Offshore Services($62)($274)($34)
BPZ Resources($158)($89)($100)
Global Industries($177)($122)($268)

Source: Yahoo! Finance. Figures in millions.

Hornbeck Offshore provides the perfect example of how closely capital expenditures can be tied to positive or negative free cash flow numbers. The two years the company spent the least on capex were were also the two years it netted positive free cash flow numbers. At this point, investors need to make sure that a history of capital expenditures matches up with long-term growth strategies.

Debt
Debt is the sort of thing that can ruin a company's future. There is such a thing as good debt, but too much of anything is never a great idea. The debt-to-equity ratio is a good way to compare the debt loads of companies of different sizes.

Company

Debt/Equity

Hornbeck Offshore Services92%
BPZ Resources76%
Global Industries42%

Source: Yahoo! Finance, as of most recent quarter.

This chart illuminates something interesting: Though it placed last in the free cash flow test, Global Industries is the best at managing its debt, while best-in-class cash flow king Hornbeck Offshore owns the worst number here.

Top dog
All of these companies have negative free cash flow closely tied to growth, but Global Industries has solid insider ownership and the best debt situation of the three. You don't need to write off the other energy companies listed here; they just don't look as promising based on these criteria.

Interested in energy stocks? Click here for the Motley Fool's Special Free Report, "The Only Energy Stock You'll Ever Need."

At the time this article was published Fool contributorAimee Duffydoesn't own shares of the companies mentioned in this article. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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