This Little Oil Stock Will Make You Rich

Rich! That's what the urgent investor alert in my mailbox told me, anyway.

That's right -- the kind-looking fellow on the cover tells me his "can't miss stock pick" can become a five-bagger in less than a year. He sent me his report -- a $7.95 value! -- free of charge. The least I can do in return is act quickly without thinking too hard about this.

I was wondering how I was going to pay for these new calf implants.

Sweet!
Who knew you could find the next Petrohawk Energy (NYSE: HK) by flipping through your snail mail? I can only hope my home address gets sold to more of these internationally acclaimed market strategists.

OK, I know you're eager to hear about the micro-cap energy stock that's going to set my portfolio on fire.

What's that? Your portfolio? You think I can tell just anyone about this opportunity? This is ground-floor stuff -- the company doesn't even trade on the American Stock Exchange yet. Sharing would be like stealing tens of thousands of dollars' worth of complimentary reports out of my new guru's trench coat.

I'm sorry, I just can't give you the name. I still want to tell you about the fundamentals of company X, though. Maybe if you come across a similar opportunity, you'll know what action to take.

A striking opportunity?
Like Petrobras (NYSE: PBR) and Apache (NYSE: APA), company X is in the market's sweet spot. The only difference is that fewer people have heard of this younger company -- though I did notice that trading volume spiked recently for some reason. Nevertheless, company X still trades at a big discount to overexposed peers like Southwestern Energy (NYSE: SWN), at least based on the price-to-sales ratio.

Sales multiples are always a handy valuation rule of thumb when a company has negative cash flows. Company X has only been around for a few years. How can we expect it to be cash-flow positive already? This company is producing thousands of barrels of oil … every year. I think that's quite an accomplishment for a company led by a failed dot-com entrepreneur.

Company X is also growing those revenues like crazy. In 2004, there were no revenues, so growth has basically been infinite. Over the past few years, that searing growth has cooled a bit, but it's hard to maintain infinite growth. That tends to draw competition, not to mention regulatory scrutiny. I'll settle for my guru's "conservative growth rate of 50% in 2009 and 2010." After all, I'm only looking to quintuple my money here. I'm not asking for a miracle.

Speaking of miracles, if everything goes right (i.e. assuming zero development costs and a 100% success rate), this little company could be sitting on $400 million worth of oil and gas. The company's year-end reserve report listed only around $20 million in present value, but I think these guys are just being modest.

Let's get serious
OK, enough with the sarcasm. This company is utter junk. Let's review some of the red flags so none of my Foolish friends get snookered in similar situations:

• A nearly exclusive focus on growth (sales, production, etc.) without proper attention paid to production costs, return on capital employed, or other key measures. See companies like Chesapeake Energy (NYSE: CHK) and Suncor (NYSE: SU) for exemplary financial reporting by oil & gas producers.
• Valuation metrics like price-to-sales that similarly ignore profitability.
• Negative operating cash flow.
• Highly promotional management without a strong industry background.

Fools, there are so many terrific E&P companies out there that there's just no reason to mess with micro caps promising the moon. You'll most likely find yourself in the gutter, looking at the stars.

Related Foolishness:

• My Foolish colleague argues that energy is the next tech wreck waiting to happen.
• I didn't mince words about the growing micro-cap mania.
• Don't get me wrong -- I love wild penny stocks, too.