Is This Oil and Gas Producer Cheap According to Graham?

Earlier this year, I spent some time dissecting Benjamin Graham's The Intelligent Investor, the seminal book on value investing. Along the way, I talked about the Graham number as a means of valuation when it comes to stocks. The formula is pretty straightforward: Multiply earnings per share by book value per share, then multiply that by 22.5, and finally take the square root. The result, in dollars, is the Graham number.

However, a quick check can help determine whether or not a company might be worthy of a look using the teachings of Graham. He said that in an ideal situation, the P/E ratio and P/B ratio multiplied together should not exceed 22.5, with a maximum P/E ratio of 15 and P/B of 1.5. With that in mind, I looked at the stocks of the S&P 500 that met the ideal situation mentioned above. Currently, there are 68 companies in the index that meet these criteria. I will be making a CAPScall on these companies after comparing them to competitors and their current value in relation to their Graham numbers. Up next is independent oil and gas producer Apache (NYSE: APA  ) .

Who are they?
Apache started in 1954 with $250,000 and some wells in Oklahoma, with a goal of profitability and survival after one year. Nearly 60 years later, Apache has succeeded, and has expanded to include operations in Canada, Egypt, Australia, and Argentina. By diversifying outside of the U.S., Apache is able to take advantage of the higher Brent pricing for crude oil, placing them in a better position than some other competitors focused primarily on North America.

However, by focusing primarily on oil, Apache may suffer as higher fuel efficiency standards come to pass. With over 75% of their current reserves in oil, they could feel the pinch due to lower demand for gasoline. Furthermore, less than stellar earnings pushed its share price within 25% of its 52-week low, providing a nice opportunity for some growth.

What's it worth?
While not at its low point, Apache is still trading at a substantial discount to its Graham number valuation:

Company

EPS (ttm)

Book Value per Share (mrq)

Graham Number

Recent Price

Upside

Apache $8.30 $75.27 $118.56 $89.90 31.9%
Devon Energy (NYSE: DVN  ) $5.93 $54.94 $85.62 $59.34 44.3%
Canadian Natural Resource (NYSE: CNQ  ) $2.65 $22.29 $36.46 $32.20 13.2%
Talisman Energy (NYSE: TLM  ) $0.60 $10.09 $11.67 $14.17 (17.6%)
EOG Resources (NYSE: EOG  ) $5.13 $49.50 $75.59 $112.88 (33.0%)

Source: Yahoo! Finance and author's calculations.

Devon Energy has some powerful allies, with New York City Mayor Michael Bloomberg having written  an op-ed in support of fracking, which Devon uses in its lucrative play in the Mississippi Lime formation. Canadian Natural Resource is the largest heavy oil producer in Canada, as well as the second-largest natural gas producer, but also has operations in the North Sea and in central Africa.

Even though they are currently priced higher than their Graham valuations, the others on the list still have attractive qualities. Talisman Energy has moved some focus to Southeast Asia, in particular Vietnam, to counter the weak natural gas market in North America. EOG Resources rode strong earnings to within 6% of its 52-week high, and maintains positions in the two most prolific U.S. oil and gas plays, boding well for the future when natural gas prices rebound.

Accountability time
A stock's valuation, regardless of the method used, is but one thing to look at when evaluating a potential investment. With room to grow into its Graham number valuation, I will be placing a "thumbs-up" over on my CAPS page in order to track this call and keep myself accountable. I will also be adding Apache Corporation to My Watchlist to stay up to date on anything that may cause me to change my opinion of the company.

There are plenty of other energy options for your portfolio beyond the companies mentioned here. In fact, our analysts have identified the one energy stock you must own before 2014. To find out which one they identified, click here to get a copy of the free report while it is still available.

Fool contributor Robert Eberhard holds no position in any company mentioned. Follow him on Twitter, or click here to see his holdings and a short bio. The Motley Fool owns shares of Apache and Devon Energy. Motley Fool newsletter services have recommended buying shares of Devon Energy. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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