Is Linn Energy the Perfect Stock?

Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?

One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if Linn Energy (Nasdaq: LINE  ) fits the bill.

The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks excel in many different areas, which all come together to make up a very attractive picture.

Some of the most basic yet important things to look for in a stock are:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
  • Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
  • Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
  • Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Linn Energy.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

82%

pass

 

1-Year Revenue Growth > 12%

7.2%

fail

Margins

Gross Margin > 35%

70.5%

pass

 

Net Margin > 15%

(4.4%)

fail

Balance Sheet

Debt to Equity < 50%

83.8%

fail

 

Current Ratio > 1.3

3.06

pass

Opportunities

Return on Equity > 15%

(0.9%)

fail

Valuation

Normalized P/E < 20

NM

fail

Dividends

Current Yield > 2%

8.3%

pass

 

5-Year Dividend Growth > 10%

17.3%*

pass

       
 

Total Score

 

5 out of 10

Source: Capital IQ, a division of Standard and Poor's. *Annualized g rowth since March 2006, when first dividend was paid. Total score = number of passes.

A score of 5 is fair, but it certainly falls short of perfect. Linn Energy has an interesting structure; it's organized in a way that's similar to master limited partnerships Kinder Morgan Energy (NYSE: KMP  ) and Enterprise Products Partners (NYSE: EPD  ) . That structure supports the healthy payouts that Linn has made. But unlike Kinder Morgan and Enterprise Products, which operate pipelines and therefore are more insulated from changes in energy prices, Linn is an exploration and production company.

As a result, Linn has seen its financial results suffer greatly from the slump in natural gas. Larger competitor Chesapeake Energy (NYSE: CHK  ) has managed to eke out operating profits even in the low-price environment, but Linn hasn't been so lucky. It'll take a rebound in gas prices to push Linn back on track to sustained profitability.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

The Motley Fool is recommending 50 stocks in 50 days for its new "11 O'Clock Stock" series. For more information, click here. Then come back to Fool.com every single weekday at 11 a.m. ET for a brand-new pick!

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Chesapeake Energy is a Motley Fool Inside Value pick. Enterprise Products Partners is a Motley Fool Income Investor recommendation. Try any of our Foolish newsletters today, free for 30 days.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


Read/Post Comments (7) | Recommend This Article (15)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 22, 2010, at 11:55 PM, mcl61mcl61 wrote:

    Hmmm. Something is amiss. Is the Fool aware that Linn has not suffered, at all, from the slump in natural gas? Linn weathers the NG slump quite well.

    How can we be so sure? Linn's positions in the gas market are fully hedged at eye popping prices for the past next years. Linn's share price has done very well if measured against its peers.

    Who did suffer from the slump in natural gas? None other than (drumroll ...) Chesapeake.

    Look Fool, you need to do just a tiny bit of research before getting all foolish on us.

    CHK ytd total return: -18.59%

    CHK one year total return: - 27.10%

    ahem ...

    LINE ytd total return: 15.35%

    LINE one year total return: 36.85%

    May the fool be with you ... and may you have gas.

  • Report this Comment On September 22, 2010, at 11:57 PM, mcl61mcl61 wrote:

    Ooops, I meant to write: Linn's positions in the gas market are fully hedged at eye popping prices for the next two years.

    Foolishly yours.

  • Report this Comment On September 23, 2010, at 8:32 AM, TMFGalagan wrote:

    Hi mcl61mcl61 -

    I was referring to net income, where Linn has lost $24 million in the past 12 months, compared to Chesapeake's $625 million profit.

    best,

    dan (TMF Galagan)

  • Report this Comment On September 23, 2010, at 9:16 AM, hungreydoggy wrote:

    If there is a point to this "article" it blows right past me.

    Of course there is no perfect investment. If there was we would all be rich. But Linn's share price keeps going up and they pay a distribution that comes to about 9% on an annualized basis. The company's production is carefully hedged to assure the distribution rate, and it looks like there will an increase in the distribution in the near future. The company is well managed. It's growing. And oil is a pretty good place to be invested for the future.

    Don't be so clever that you miss out on a good thing.

  • Report this Comment On September 23, 2010, at 10:26 AM, mcl61mcl61 wrote:

    Hi Dan, it's important to remember that net income is not the best yardstick when analyzing a company with an MLP-like structure.

    If focusing on net income, yes, LINE looks like it suffered. But cash flow and coverage are good.

    LINE came thru the financial crisis and the nat gas tankage almost unscathed and the market seems to agree as evidenced by the unit price.

    CHK has yet to recover. Perhaps better to compare LINE to an MLP - there are lots of them out there.

    Yours in foolishness ...

  • Report this Comment On September 25, 2010, at 4:36 PM, jkheycke wrote:

    You need to go back and study some accounting. The GAAP earnings do not account for the enormous gains LINE has realized on their hedges, which completely offset the lower prices at the wellhead. A few years ago, LINE set in hedges for over 100% of production at absurdly high prices (e.g. $9/mcf).

    The funny thing is they actually make more money when prices go down, because their costs (e.g. wellhead taxes) are lower, but their revenue is fixed by the hedges.

    Get a clue!

  • Report this Comment On September 29, 2010, at 1:49 AM, philkek wrote:

    Thanks MF and fellow fools. Good educational article and public comments to help fools like me get back to the business of investing. I have learned a little more about fundamentals today. Fool on for profits.

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