Is Penn West Energy the Perfect Stock?

Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?

One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide whether Penn West Energy (NYSE: PWE  ) fits the bill.

The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.

Some of the most basic yet important things to look for in a stock are:

  • 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 don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
  • Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
  • Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
  • Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. 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.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

14%

fail

 

1-Year Revenue Growth > 12%

(13.5%)

fail

Margins

Gross Margin > 35%

60.6%

pass

 

Net Margin > 15%

10.6%

fail

Balance Sheet

Debt to Equity < 50%

32.9%

pass

 

Current Ratio > 1.3

0.75

fail

Opportunities

Return on Equity > 15%

3.2%

fail

Valuation

Normalized P/E < 20

NM

fail

Dividends

Current Yield > 2%

8.9%

pass

 

5-Year Dividend Growth > 10%

28.7%

pass

 

Total Score

 

4 out of 10

Source: Capital IQ, a division of Standard and Poor's. NM = not meaningful; normalized earnings were negative during the period. Total score = number of passes.

A score of 4 doesn't bring Penn West close to perfection. As a Canadian royalty trust, Penn West has been forced to confront the looming end of its favored tax status, as well as a big drop during the oil bust in late 2008. Yet unlike fellow CanRoy Precision Drilling (NYSE: PDS  ) , Penn West has still paid sizable dividends, although a recent cut in its payout will further reduce its already smaller payout compared with its 2007 peak.

On the whole, Penn West falls into the middle of the pack of energy trusts based on these factors. Pengrowth Energy (NYSE: PGH  ) sports better margins and an even healthier balance sheet, and its revenue stream has been somewhat less volatile than Penn West's. Provident Energy (NYSE: PVT  ) , on the other hand, has higher debt levels, slower long-term revenue growth, and lower margins.

Uncertainty about the coming CanRoy conversion has investors nervous about Penn West. If energy prices rebound, though, it and all of the energy trust stocks should benefit.

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.

The Motley Fool is recommending 50 stocks in 50 days for its new "11 O'Clock Stock" series. For more information, click here. Then come back to Fool.com every single weekday at 11 a.m. ET for a brand-new pick!

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Precision Drilling is a Motley Fool Global Gains selection. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (17)

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  • Report this Comment On September 30, 2010, at 8:58 AM, BernieSr63 wrote:

    You've given a lot of solid information. It all looks consistent with what my views have been. In order to keep their tax benefit they have to pay out 90% of their net profit to their share-holders.

    Great! Except for a month last winter they've paid a dividend each month like clockwork

    What has me concerned, and I've sold off 525 shares and kept a few in case. A person I respect suggested I take a defensive position for the next few months because PWE is likely to go public in the next two quarters or so. That seems to me that PWE will be getting into an area of uncertainty relative to the dynamics in the value of the shares. If they go to an IPO in a big way the individual shares may be diluted to a possible two or three year low valuation.

    With their tax base changing the dividend may be non-existent for an extended period as they find a base they can't define at this point.

    The other side of the idea is that they may be able to seamlessly step into their new reality. If that is the case, I'll be back into them. I just can't tell what direction they will move to with this 180 degree shift.

  • Report this Comment On September 30, 2010, at 11:37 AM, DenisHancock wrote:

    The simple pass /fail analysis can be relatively misleading in this context - a binary metric around a rather arbitrary threshold.

    For example, if 15% annual revenue growth over the last 5 years is considered so good, it's hard to see how 14% should be a "fail" (i.e. the same score a company with declining revenue would get). And on the dividend side, if 2% yield with >10 % growth is considered a pass, then a 8.9% yield + 28.7% growth should be like an A+.

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