Last week we looked at the best ways to invest in oil, which in my experience has been to choose energy exploration-and-production companies with a high oil-to-natural-gas ratio.

Now, I do like natural gas and I have led my subscribers to several profitable positions in natural gas stocks. But oil is a higher-margin business than natural gas.

And with oil prices trending just below the $100 mark, this segment is offering a lot of intriguing entry points right now.

So, you know I like E&P companies with a lot of proven oil reserves. And the way I find values among these names is thanks to one important metric: enterprise value.

Here’s how it could help you become a more-profitable energy trader …

An Enterprising Way to Pick Oil Stocks

The enterprise value is essentially the market value (or shares outstanding times the current price; the cost to acquire the company) plus long-term debt, divided by its proven barrels of oil equivalent (BOE).

I believe this metric is one of the most-important valuation metrics investors should consider when investing in E&P companies.

In calculating the debt, I use all the long-term debt and liabilities, minus short-term debt. I do not add the short-term debt, but look instead at the current ratio; which is normally more than a wash.

(This is a conservative way to value reserves. The value that I come up with is generally understated.)

We Don’t Need $200 Oil to
Make Money With Oil Stocks Now

Some investors and analysts would argue that the market value of reserves is not a good measure of valuation because it takes time to produce those reserves and it could be costly.

I believe the valuation is fair and considerably conservative, because the calculation does not include possible and probable reserves, potential new discoveries, and the prospect that oil can get to $200 and above over the next three-to-five years.

If possible and probable reserves were included for some of the companies, the valuations would fall down to about $5 a barrel.

Cheaper Oil, Bigger Gains?

Here are the top 10 companies that have the cheapest market value for their reserves.

Currently the price of oil is around $100, and I think over time it will surpass its all-time high of $147. Honestly, these stocks are cheap when I consider the potential price of oil.

Some of the companies such as Suncor Energy (SU) and Canadian Natural Resources (CNQ)have other significant operations that overstate the market value of their reserves.

Below are Finding and Development (F&D) company costs, with the lowest costs listed first and the more expensive listed last.

This metric is important because it could tell us which company has the best management, margins, profits, cash flow, drilling success and fundamentals.

Wall Street tends to like these companies the best. However, I believe the reserve metrics are more important.

E&P companies are asset stories and less earnings growth stories. I want to own access to valuable, essential and depleting oil reserves.

Identifying F&D costs is difficult. I had to use some of the components of the income statement to come up with costs. Some companies provided average costs over a three-to-five year period.

(The comparisons may not be apples to apples; e.g., some of the companies have low costs because they have high natural gas reserves, and these reserves bring down their costs compared to the costs of oil reserves.)

Bill Barrett Corp. (BBG) is an example. BBG is 58% natural gas, 42% oil and natural gas liquids, and sales over production is $39.95 per BOE. This means, they are selling more natural gas and natural gas liquids vs. oil.

When I started analyzing these companies back in 2004, the average F&D costs were about $6. F&D costs increased almost fourfold to an average of about $21.87.

Increased F&D costs are one of the reasons why oil prices have gone up. In 2004, oil prices were around $30 and prices are up about fourfold; that is about the same proportion as the rise in F&D costs.

Below is a comparison of enterprise values and F&D costs for timelines in previous studies:

Let’s review the table:

• Notice that the enterprise value is less than F&D costs. In other words, it is cheaper to buy these stocks than to go out and “find and develop” oil.

• There was a big gap between enterprise value and F&D costs in 2006. The energy story did not catch on very well.

• E&P companies remain a bargain; their market value is cheaper than their costs. In 2013, their reserves are selling at a discount — $19.23 vs. $21.87 to find and develop. It would be cheaper to acquire an E&P company vs. finding and developing reserves.

The next group of metrics should be fundamentals; especially, debt and investment quality metrics.

For the second week in August, I will do an update for gold and silver. For the third week, I will follow up with an analysis of the fundamentals of these companies and for the fourth week, I will take a look at the technicals.

Good gold and energy investing,
Dan Hassey

P.S. My Gold and Energy Investor members receive priority access to my special reports, research and timely recommendations. In fact, I’m putting the finishing touches on their next round of trades and I’ll be looking to release those in the coming days. I’d love to have you on board — click this linkto see if this service may be right for you.

http://www.uncommonwisdomdaily.com/10-energy-stocks-to-profit-from-cheap-oil-18729