Best Buy: Linn Energy, Chesapeake Energy, or SandRidge Energy?

In this Motley Fool series, we rank three related stocks on five criteria to determine the best buy.

Today's matchup is a natural gas battle between Linn Energy (Nasdaq: LINE  ) , Chesapeake Energy (NYSE: CHK  ) , and SandRidge Energy (NYSE: SD  ) .

• Linn Energy is an exploration and production (E&P) company set up as a limited liability company. Like a Master Limited Partnership (MLP), Linn Energy's structure combines the tax benefits of a limited partnership with the liquidity of a public company. MLP's are more commonly pipeline plays like Kinder Morgan Energy Partners (NYSE: KMP  ) or Enterprise Products Partners (NYSE: EPD  ) than E&P's -- the pipelines charge by volume so are relatively unaffected by swinging oil and gas prices. This is useful as they meet their quarterly required distributions (QRD's) -- basically dividends.
• Chesapeake Energy is laser-focused on extracting natural gas from shale plays. However, its actions are frequently overshadowed by those of its co-founder/chairman/CEO, Aubrey McClendon (read more here).
• SandRidge Energy is the smallest of the three (Chesapeake is by far the largest) and besides its E&P work provides services to other E&Ps.

The natural gas industry has seen better days, but when there are tough times, there is frequently opportunity. Using five short-of-scientific-but-carefully chosen criteria, let's determine which of these plays is the best buy.

Round 1: Balance sheet
SandRidge has negative equity and an ungodly amount of debt, so it brings up the rear. Chesapeake is about 50/50 on the debt vs. equity funding, but Linn is the least leveraged with debt making up a reasonable third of capital. Rank: 1) Linn, 2) Chesapeake, 3) SandRidge.  

Round 2: Operations
This one is easy. Forget net income, Chesapeake is the only one with current operating profit. That's impressive in these trying times for natural gas producers. If you haven't been following the industry, natural gas prices are quite depressed due to oversupply. Rank: 1) Chesapeake, 2) Linn, 3) SandRidge.

Round 3: Price
Since the price of underlying assets can change so drastically, price-to-book ratios can be tricky for certain industries. At the extreme, it's next to worthless for companies whose inventories can become obsolete. For example, JA Solar Holdings (Nasdaq: JASO  ) and Evergreen Solar (Nasdaq: ESLR  ) have reasonable (1.4 for JA) to yowza! (0.5 for Evergreen) price-to-book ratios. Value investors get really excited when price-to-book ratios get to around 1.0 or lower, but the book values of inventory and machinery are based on their respective solar technologies which wouldn't be worth much use in liquidation if the businesses are hurt due to technological obsolescence. The natural gas producers aren't quite at that level. Long-term depressed pricing, not obsolescence, is the big fear for them. Using forward price-to-earnings ratios, which can suffer from optimistic assumptions, the companies fall in line after Chesapeake's ratio of 7.4... Rank: 1) Chesapeake, 2) SandRidge, 3) Linn.

Round 4: X Factor
For better or worse, Chesapeake takes this one because it's the purest natural gas play and Aubrey McClendon is, well, a character. The X Factor could go either way, but for the possibility of a surprise, Chesapeake leads this group (again, for better or worse). Rank: 1) Chesapeake 2) SandRidge 3) Linn

Round 5: CAPS rating
Our CAPS community loves all three of these stocks. They rate Linn and Chesapeake 5 stars (out of 5) and SandRidge 4 stars. Rank: 1) (Tie) Linn and Chesapeake 3) SandRidge.

The summary rankings

Category	Linn Energy	Chesapeake Energy	SandRidge Energy
Balance Sheet	1	2	3
Operations	2	1	3
Price	3	1	2
X-Factor	3	1	2
CAPS Rating	1	1	3
Average Finish	2.0	1.2	2.6

There you have it. Chesapeake Energy dominated these rankings, finishing first in four of the five categories. Linn Energy takes the silver. And SandRidge Energy gets some parting gifts. But what do you think? Declare your winner in the poll below and then share your thoughts in the comments section below the poll.