What's the Best $5 Energy Stock to Buy?
There is something about a cheap-looking stock price that seems to tempt investors. When a stock gets down below $5 it's hard not to think about how easy it would be for that stock to double into a $10 stock and still look cheap. Savvy investors will of course realize that a $5 stock could actually be a very expensive stock. You can often find a stock trading at over $100 per share that is cheap while one trading below $5 can be ridiculously expensive. That being said, sometimes stocks are beaten down so badly by the market that there are some great values to be found.
In the energy sector there are several interesting energy stocks currently selling for $5 a share or less. However, when you compare the values, there is just one that takes the crown of the best stock to buy. To get a better idea of value you have to drill down deeper and that's where a company's enterprise value comes into play. Here's a look at the enterprise values of five popular energy stocks trading for $5 a share or less.
Current Market Cap
Magnum Hunter Resources
Source: Company SEC filings and author's calculations. * Enterprise value includes outstanding preferred stock.
We can make plenty of observations from the above chart as several numbers really jump out. Quicksilver really stands out for how much debt the company has on its balance sheet not just when compared to its peers but in terms of its total enterprise value. That alone might not make it the best stock to buy, as too much debt adds to a company's risk. That's why it's important to see how much debt adds to the overall enterprise value of the companies on this list. Abraxas has the least amount of leverage on the list while Quicksilver and Halcon have taken on more leverage.
These leverage ratios factor into the reasons why these stocks are trading in the $5 per share range -- the market hates companies that have too much debt. One other thing that I will point out is that both SandRidge and Magnum Hunter have more reasonable debt to enterprise values though both do have preferred shares which could count as debt. The bottom line is that when looking at a company's value, it's best to look deeper than just its stock price before you buy.
Source: SandRidge Energy
Looking at the enterprise value for an energy company provides a more accurate picture of what investors are really paying for the company as a whole. That's because from here we can then take a look at how a company is trading against its EBITDA, which is a good proxy for its potential cash-generating ability. It also gives you an idea of what a potential acquirer might be willing to pay for the company in question. By dividing its enterprise value into its trailing-12-month EBITDA we get a ratio which paints a clearer picture than a price to earnings ratio, which can be deceiving because many of these companies don't have any earnings:
Magnum Hunter Resources
Source: Company SEC filings and author's calculations. * Magnum Hunter TTM EBITA as of last filed 10-Qs.
Here again we can make some distinct observations. When looking at SandRidge and Halcon, both stocks are trading around $5 per share, but the best stock to buy is clearly SandRidge if you are looking to buy a cheap stock. That's even after taking into account the fact that SandRidge recently sold its Permian Basin assets which has inflated its trailing-12-month EBITDA a little bit (pro forma the EV/EBITDA ratio is closer to five times). Even with that adjustment SandRidge is trading well below these peers.
Final Foolish thoughts
The numbers are pretty clear, if you are looking to buy a cheap stock, the best of this bunch to buy is SandRidge Energy. That opinion doesn't take into consideration how fast a company is growing its EBITDA, nor does it account for any value of hidden assets like undeveloped reserves. Think of this as a good starting point and a reminder that a stock's value has nothing to do with its price.
The next step for investors is to drill down even deeper SandRidge Energy and see if there is another reason why shares appear to be so cheap. We know that shares of SandRidge plummeted when natural gas prices plunged but this is a different company now as its focusing on growing its liquids production which has its future looking optimistic. To learn more about the future of this emerging oil and gas junior check out The Motley Fool's premium research report detailing SandRidge's game plan and what to expect from the company going forward. To get started, simply click here now!
The article What's the Best $5 Energy Stock to Buy? originally appeared on Fool.com.
Fool contributor Matt DiLallo owns shares of SandRidge Energy. Matt DiLallo has the following options: Short Sep 2013 $5 Puts on SandRidge Energy. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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