Which Oil Services Stock Should You Buy Today?

Welcome to "Stock Smackdown," where two of your favorite stocks go head to head in a battle for superiority. They'll each be judged on a series of objective merits, including valuation, earnings quality, and dividend quality. We'll also take a look ahead at some more subjective measures. Wall Street's analysts will get their say, but so will The Motley Fool's top market minds.

The winner will be the stock that racks up the most victories at the end of their competition. Let's go to ringside and meet our two combatants, Halliburton (NYSE: HAL) and Seadrill (NYSE: SDRL).

In this corner...
This is, in some ways, a battle of land and sea. Halliburton's well-known battle with BP (NYSE: BP) over Deepwater Horizon liability has produced major downward pressure on its stock for some time, but Halliburton's growth potential has been largely tied (at least in the financial press) to unconventional land oil and gas exploration. That means fracking, which Halliburton's been instrumental in developing and deploying across America.

While Halliburton has a strong presence on ocean-based rigs, it's Seadrill that's pegging its future on the great unexplored depths of the sea. It's entirely focused on ultra-deepwater drilling, while seaborne peers like Transocean (NYSE: RIG) -- the third party in BP and Halliburton's three-way game of Deepwater Horizon hot potato -- maintain a full spectrum of offshore operations,  but does not have the same quality of ships as Seadrill.

Seadrill is a much younger company than Halliburton and has issued a lot of debt to build out its fleet of drilling rigs. That youth is actually an advantage in a competitive field, since newer and better-built rigs ought to be more suited to the treacherous conditions of ultra-deepwater drilling.

Now, let's get the battle started.

Valuation battle
We use many different numbers and ratios when talking about the value of a stock. The price-to-earnings ratio is the standard, so we'll check each company's current P/E and five-year historical average P/E. The difference between a stock's current ratio and its five-year average ratio will be more important than the numbers themselves. Stocks trading significantly lower than their average ratios may have more room to return to that middle ground.

We'll also use price to free cash flow today. Earnings can be gamed with a number of different accounting tricks, but free cash flow is harder to manipulate, making it a favored metric here at the Fool. Finally, we'll check one less-used financial metric: the debt-to-equity ratio. A company with little or no debt is usually in better shape than one leveraged to its eyeballs.

Source: Wolfram Alpha and Morningstar. Winners in bold.
NM = not material due to negative results.

Halliburton takes this round with a clean sweep. Even though its free cash flow levels are substantially lower than its net income due to high capital spending, Halliburton's at least maintained positive cash flow levels over time. Will Seadrill take the next round? Let's find out.

Earnings quality battle
A company can be cheaply valued without being a good value. To balance out our valuation fight, let's look at a few key earnings statistics for each company. We'll look at gross and net margins, a five-year annualized rate of earnings growth, and consecutive years of both positive earnings and earnings growth since 1992, two decades ago. A company with no momentum today is less likely to become a superstar later -- it has happened before, but not often.

Sources: Morningstar. Winners in bold.

Despite Halliburton's longer streaks of earnings and earnings growth, Seadrill takes the earnings quality crown! Can it fend off Halliburton in the dividend battle ahead?

Dividend battle
A growing company is great, but one that pays you back is even better. Since both companies are paying dividends today, let's see how strong and stable they really are. We'll examine yield, the earnings and free cash flow payout ratios, the five-year annualized dividend growth rate, and each company's current streak of uninterrupted payments.

Those payout ratios are important, particularly the free cash flow payout ratio. Companies that pay out more than they take in can rarely sustain such practices for long.

Sources: Morningstar and Dividata. Winners in bold.
NM = not material due to negative results or insufficient history.

Halliburton comes back to become the dividend champion. Seadrill just hasn't paid out dividends long enough to compete. Can Seadrill survive the final rounds?

Battle for the future
Looking at the past is well and good, but let's go further. How do the world's most engaged market participants view these companies? Let's see what Wall Street's analysts expect from these companies, and what our Motley Fool CAPS community thinks.

Sources: Yahoo! Finance, Motley Fool CAPS.

We've got a tie on our hands after four rounds, with Seadrill sporting a hefty forward growth rate and near-unanimous CAPS sentiment. The toughest (and most subjective) battle awaits: potential! Just what lies in store for each company in the months and years ahead?

It's generally easier to identify and exploit new land-based sources of energy, and in this regard, Halliburton ought to have the clear lead. Some highly optimistic assessments assert that there may be up to 1.5 trillion barrels of oil in recoverable reserves in the United States alone. If even a fraction of those reserves are developed, it would substantially boost Halliburton's earnings potential before nat-gas fracking even comes into play.

Global offshore reserves are much smaller than those known onshore. Total known deepwater reserves range from about 25 billion barrels to perhaps 150 billion barrels at the high end. That may seem like a lot, but it's far less oil than that in known Saudi Arabian reserves -- the world's leading oil producer has about 265 billion barrels in its territory. The upside is that reserves, both on and offshore, are often revised upwards as the technology to identify and extract difficult oil improves. Seadrill will be able to capitalize on new discoveries, but so will Halliburton. Fool analyst Jason Moser points out that increased rig counts also benefit Halliburton, which provides the support systems to keep those billion-dollar floating buildings operational.

Halliburton's diversity makes it look like the better buy today. It's not just squeaking past Seadrill, it also bests many of its more direct peers. Halliburton has a higher enterprise value to EBITDA than oil-services rival Baker Hughes (NYSE: BHI) and also sports a much better return on assets, as Fool contributor Isac Simon pointed out earlier this summer. After all the points are tallied, it looks like Halliburton's the winner of today's Stock Smackdown.

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