Does Kodiak Oil & Gas Look Like A Home Run Stock?

As investors, we always want our investments to generate a healthy return. However, investors often forget that returns stem from two, not one, extremely important factors:

  1. the business's ability to generate profits and
  2. the price you pay for one share of those profits.

This idea of price versus returns provides the bedrock for value investing. In this series, I'll examine a specific business from both a quality and pricing standpoint, in hopes of gleaning a better sense of its potential as an investment right now.

Where should we start to find value?
As we all know, the quality of businesses vary widely. A company that can grow its bottom line faster (sometimes much faster) than the market, especially with any consistency, gives its owner greater value than a stagnant or declining business. (Duh!) However, many investors also fail to understand that any business becomes a buy at a low enough price. Figuring out this price-to-value equation drives all intelligent investment research.

In order to do so today, I selected several metrics that will evaluate returns, profitability, growth and leverage. These make for some of the most important aspects to consider when researching a potential investment.

  • Return on equity divides net income by shareholder's equity, highlighting the return a company generates for its equity base.
  • The EBIT (short for earnings before interest and taxes) margin provides a rough measurement of the percent of cash a company keeps from its operations. I prefer using EBIT to other measurements because it focuses more exclusively on the performance of a company's core business. Stripping out interest and taxes makes these figures less susceptible to dubious accounting distortions.
  • The EBIT growth rate demonstrates whether a company can expand its business.
  • Finally, the debt-to-equity ratio reveals how much leverage a company employs to fund its operations. Some companies have a track record of wisely managing high debt levels. Generally speaking, though, the lower this figure, the better. I chose to use five-year averages to help smooth away one-year irregularities that can easily distort regular business results.

Keeping that in mind, let's take a look at Kodiak Oil & Gas (NYSE: KOG  ) and some of its closest peers.

Company Name

ROE (5 year avg.)

EBIT Margin (5 year avg.)

EBIT Growth (5 year avg.)

Total Debt / Equity (%)

Kodiak Oil & Gas (33.3%) (38.4%) NM* 35.4%
Magnum Hunter Resources (NYSE: MHR  ) (31.1%) (96.9%) NM* 23.1%
Quicksilver Resources (NYSE: KWK  ) 6.9% 44.2% 22.3% 183.5%
Brigham Exploration (Nasdaq: BEXP  ) (24.7%) (43.7%) (20.1%) 89.7%

Source: Capital IQ, a Standard & Poor's company.

These companies' past performances don't look overly encouraging. Out of the four, only Quicksilver managed to produce positive figures for return on equity, operating margin, and growth. On the other hand, Quicksilver carries the highest debt burden, making it look pretty risky on the surface. However, high oil prices and expectations for nat gas's fairly bright future could help drive better performance.

How cheap does Kodiak Oil & Gas look?
To look at pricing, I chose to examine two important multiples: price to earnings, and enterprise value to free cash flow. Similar to a P/E ratio, comparing enterprise value (essentially, debt, preferred stock, and equity holders combined,minus cash) to unlevered free cash flow conveys how expensive the entire company is, relative to the cash it can generate. This gives investors another measurement of cheapness when analyzing a stock. For both metrics, the lower the multiple, the better.

Let's check this performance against the price we'll need to pay to get our hands on some of the company's stock.

Company Name

EV / FCF

P / LTM diluted EPS before Extra Items

Kodiak Oil & Gas (4.1) 299.6
Magnum Hunter Resources (4.6) NM
Quicksilver Resources (7.7) 4.2
Brigham Exploration (9.4) 37.4

Source: Capital IQ, a Standard & Poor's company.

The disappointing results seen in the first chart continue here as well. While all of these companies managed to generate positive cash flow from their operations, capital expenditures managed to completely negate that cash. Quicksilver's earnings multiple looks attractive, but the earnings themselves look pretty ephemeral. Its cash generation looks about as abysmal as the rest of this group.

Going off past performance, all four of these companies look like stocks to avoid. However with nat gas gaining in popularity, they could have better days ahead of them.

While Kodiak Oil & Gas stock doesn't look like a winning stock on the surface, the search doesn't end here. In order to really get to know a company, you need to keep digging. If any of the companies mentioned here today piques your interest, further examining a company's quality of earnings, management track record, or analyst estimates all make for great ways to further your search. You can also stop by The Motley Fool's CAPS page where our users come to share their ideas and chat about their favorite stocks or click HERE to add them to My Watchlist.

Andrew Tonner holds no position in any of the companies mentioned in this article. 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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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 August 30, 2011, at 11:27 AM, kirkydu wrote:

    Wrong type of analysis for these types of companies.

  • Report this Comment On September 03, 2011, at 11:25 PM, dmitty08 wrote:

    Kirkydu, Can you please elaborate on your comment?

    Is Andrew Tonner, the author using metrics and anaylsis for much more mature companies and stocks with larger market caps?

    It seems KOG is at the top of everyone's list of the Rockin' the Bakken stocks. I'm thinking Cramer's advice of buying a basket of the best ND drillers and letting themselves whittle down through attrition and keeping the "best of breed" could give you the best calculated risk to win on these small cap question marks. Responses?

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