Has Chesapeake Energy 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 Chesapeake Energy (NYSE: CHK  ) 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 Chesapeake Energy.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 8.3% Fail
  1-Year Revenue Growth > 12% 7.3% Fail
Margins Gross Margin > 35% 42.3% Pass
  Net Margin > 15% 11.9% Fail
Balance Sheet Debt to Equity < 50% 65.3% Fail
  Current Ratio > 1.3 0.55 Fail
Opportunities Return on Equity > 15% 7.4% Fail
Valuation Normalized P/E < 20 13.50 Pass
Dividends Current Yield > 2% 1.5% Fail
  5-Year Dividend Growth > 10% 8.3% Fail
       
  Total Score   2 out of 10

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

Surprisingly, Chesapeake has deteriorated significantly from last year on this scale; when we looked at Chesapeake last year, it had a much better score of four. Lackluster revenue growth and stagnant dividend payouts cost the energy giant two points, but the company is moving in new directions to overcome the malaise in the natural gas industry.

Natural gas prices have stayed in the dumps for years now. That hasn't only hurt direct gas plays like United States Natural Gas (NYSE: UNG  ) but also companies like Chesapeake and EOG Resources (NYSE: EOG  ) that historically focused on gas. In response, both Chesapeake and EOG have placed greater emphasis on developing oil and other liquid fuels over gas, and the strategy has helped the company immensely. For instance, a joint venture with CNOOC (NYSE: CEO  ) to drill the lucrative Eagle Ford region looks like it could grow strongly in the years ahead.

But that doesn't mean that the company has given up on gas entirely. It's making a big move in the new Utica Shale play, where speculative ventures such as EV Energy Partners (Nasdaq: EVEP  ) and Magnum Hunter Resources (NYSE: MHR  ) are going up against big companies like Chesapeake and Hess (NYSE: HES  ) . Chesapeake has a lead there, although concerns about fracking could raise problems even if the play proves to be successful.

Chesapeake continually faces criticism that its CEO earns more than he deserves, even during periods of underperformance. But the real culprit for shareholders is the failure of natural gas to take off as a viable energy alternative to oil-based products. Until that mind-set changes, Chesapeake isn't going to become the perfect stock.

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 Chesapeake Energy 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. Motley Fool newsletter services have recommended buying shares of Chesapeake Energy. 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.


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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 October 04, 2011, at 2:08 PM, gcmagone wrote:

    Along with Magnum Hunter,in the Utica there is also REXX & GPOR that stand to profit from Chesapeake's drilling.

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