Keep an Open Mind

 | Jul 24, 2012 | 3:30 PM EDT
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I have recently discussed how energy stocks are one of the few truly cheap sectors of the stock market. In addition to the large drop in natural gas prices, which has gotten all the headlines, oil prices weakened in the second quarter as well. Oil initially declined by roughly 28% before rebounding in the past few weeks. On the New York exchanges they are still roughly 20% off the highs for the year. Performance numbers for the exploration and production companies as well as the oil service stocks have followed pretty much the same track as the commodities. The price weakness has sent me scouring the oil sector for ideas.

It is no secret that I make my stock selections based on underlying asset value. I do not usually pay a lot of attention to price-to-earnings (PE) ratios or analyst forecasts. I find them to be unreliable indicators of absolute value so I pretty much ignore them. This doesn't mean they are wrong or that others can't successfully use them to pick stocks. I do try to be pretty open-minded, so when I received an email from Professor Mark McNabb (also known as the Voo-Doo Prof) with some earnings growth compared to PE stock picks, I looked a little deeper.

McNabb is the Director of the M.S. Program  in Finance at University of Texas at Dallas and is a very astute investor and observer of markets. He recently had his class put together a spreadsheet of energy related stocks with PE ratios below 11 and expected earnings growth over the next two years of greater than 10%. The spreadsheet had some interesting names with strong price appreciation potential, so I begged the good professor's permission to share with readers. He kindly agreed.

A few of the names will be familiar. Hess Oil (HES) is one of my favorite energy picks and with a current PE of 7 and expected growth of almost 11%, the company makes the cut. Nabors Industries (NBR) is another one of my favorites in the group. It also makes the list of potential undervalued energy growth names as it has a PE ratio of one-third the expected growth rate. Both stocks also trade below tangible book value and are considered too cheap not to own at current levels.

Some of the more intriguing names are those that might never hit my normal screens. Matador Holdings (MTDR) is an oil-and-gas company that focuses on exploration and production in the unconventional US fields. Its primary operations are in the Eagle Ford and Haynesville fields. Like many companies that operate in the unconventional fields, they have been switching focus from natural gas to oil and liquids. Matador seems to be achieving that goal more quickly than many of its competitors. Capital expenditures for 2012 will be 94% focused on oil and liquids operations and oil production is expected to rises by tenfold, year-over-year. So far, the company is on track to meet its goals. Earnings are expected to grow by 179% annually but the current price-to-earnings ratio is just 8.2. If it comes anywhere close to the estimates, the stock is extraordinarily cheap candidate for growth investors.

Global Geophysical (GGS) is another stock that probably wouldn't make my usual lists, but it may be very attractive to growth investors. The company provides seismic data to the oil and gas industry and has shown consistent growth. Over the past five years, revenues have been growing by 35% while earnings compounded by 14% annually. For the next few years, earnings are expected to explode by more than 100%; right now, the stock trades at just 6x earnings. The stock also trades for less than 3x free cash flow and has an enterprise value (EV)/earnings before interest, taxes, depreciation and amortization (EBITDA) ratio of just 2.5, so it is cheap on several earnings metrics. Insiders own 44% of the shares and at least one has been a buyer in recent weeks. The stock is down more than 60% over the past year, but it could surge higher as oil prices improve over the next two years.

Keeping an open mind is critical for long-term success. When someone with a long record of success and strong idea generation like Dr. McNabb suggests a strategy, investors should give it due consideration.

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