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, and 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

Five-year annual revenue growth > 15%

10.8%

Fail

 

One-year revenue growth > 12%

31.9%

Pass

Margins

Gross margin > 35%

46.2%

Pass

 

Net margin > 15%

18.7%

Pass

Balance sheet

Debt to equity < 50%

73.6%

Fail

 

Current ratio > 1.3

0.72

Fail

Opportunities

Return on equity > 15%

13.9%

Fail

Valuation

Normalized P/E < 20

9.37

Pass

Dividends

Current yield > 2%

1.8%

Fail

 

Five-year dividend growth > 10%

7.2%

Fail

       
 

Total Score

 

4 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Chesapeake Energy last year, the company has gained back the two points it lost between 2010 and 2011. But shareholders have still had to suffer a 20% loss over the past year as the controversial company has remained in the spotlight for less-than-ideal reasons.

Chesapeake has had a controversial history, and the past year has been no exception. Back in April, news came out that the company had given CEO Aubrey McClendon more than $1 billion in loans to finance his taking a direct investment interest in Chesapeake wells. That was closely followed by the revelation that McClendon was running a commodities hedge fund, which renewed calls for the company to oust the CEO.

All of this controversy has largely overshadowed Chesapeake's actual operations and financial results. The company has taken several steps to raise capital, including the sale of most of its Permian Basin assets to Chevron (NYSE: CVX  ) and Royal Dutch Shell for $3.3 billion. Moreover, Chesapeake has spun off other assets into its Chesapeake Granite Wash Trust (NYSE: CHKR  ) , following the same playbook as SandRidge Energy (NYSE: SD  ) in creating royalty trusts as an easy way to raise cash without finding a single buyer for assets.

Like most natural-gas-rich companies lately, Chesapeake has been trying to move away from dry gas to more lucrative gas liquids and oil production. But with Devon Energy (NYSE: DVN  ) and a host of other competitors all moving in the same direction, divesting gas assets profitably is an uphill battle.

For Chesapeake to keep improving, it needs natural-gas prices to rise substantially from their recent lows. More importantly, shareholders need confidence that the company's CEO is acting in their best interests. Without that assurance, Chesapeake will never reach perfection.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfection than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate the best investments from the rest.

Chesapeake Energy co-founder Tom Ward now runs SandRidge Energy, and Chesapeake investors could learn a lot from what their former President and COO is doing at SandRidge. We've got all the latest about the company in the Fool's premium report on SandRidge Energy. For in-depth analysis and free updates, don't wait another minute -- click here and get in the know today.

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

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. The Motley Fool owns shares of Devon Energy. Motley Fool newsletter services have recommended buying shares of Devon Energy and Chevron. 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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