Has Penn West Petroleum Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Penn West Petroleum (NYSE: PWE  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • 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 mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. 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 Penn West Petroleum.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-year annual revenue growth > 15% 11.7% Fail
  1-year revenue growth > 12% 8.9% Fail
Margins Gross margin > 35% 62.3% Pass
  Net margin > 15% (2%) Fail
Balance sheet Debt to equity < 50% 33.2% Pass
  Current ratio > 1.3 0.53 Fail
Opportunities Return on equity > 15% (0.6%) Fail
Valuation Normalized P/E < 20 NM NM
Dividends Current yield > 2% 6.9% Pass
  5-year dividend growth > 10% (20.3%) Fail
       
  Total score   3 out of 9

Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.

When we looked at Penn West Petroleum last year, it managed a slightly better score of four. The hit came from the former royalty trust's decision to cut its dividend, reversing a trend of dividend growth in past years.

We knew several years ago that the writing was on the wall for Canadian royalty trusts, whose favorable tax status was the victim of changes in Canadian law back in late 2006. Like peers Pengrowth Energy (NYSE: PGH  ) , Enerplus Resources (NYSE: ERF  ) , and Provident Energy (NYSE: PVX  ) , Penn West had to convert to corporate status, and the loss of tax benefits forced it to cut its dividend substantially.

But Penn West and its peers aren't the only Canadian companies struggling right now. Even larger players including Suncor Energy (NYSE: SU  ) , Canadian Natural Resources (NYSE: CNQ  ) , and Encana (NYSE: ECA  ) have had a hard time with lackluster natural gas prices and falling crude oil markets.

The answer for Penn West is simple: If the energy markets cooperate, then the company is well-poised to take advantage. But right now, with oil and gas both seeing pressure from fears of a global economic collapse, Penn West won't get closer to perfection without a big improvement in the outlook for the future.

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.

Click here to add Penn West Petroleum to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our "13 Steps to Investing Foolishly."

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. 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 Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (4)

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  • Report this Comment On September 30, 2011, at 10:35 AM, FoolZim wrote:

    Another concern that keeps PWE from being the 'perfect stock' is the payout ratio. Even with the loss of favorable tax status and reduced dividend, the payout is still over 100%. A large dividend doesn't mean much unless it is sustainable, and a future reduction in dividends would surely affect share price negatively.

  • Report this Comment On September 30, 2011, at 11:49 AM, BBBoston wrote:

    FoolZim, you're wrong. You're lumping together last year's payouts (when the company was a trust, with substantially all of cash flow distributed to beneficiary-shareholders, thereby generating high payouts with virtually no reported earnings) with this year's payouts. The company is presently paying out less than 50% of its earnings in dividends.

    Similar errors are embedded in Caplinger's article.

    People, please learn how trusts operate before posting ill-informed comments. Or, if you love to blindly crunch numbers, wait until next year when the trailing 12 month data will reflect a full year of operation as a corporation.

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