National Oilwell Varco (NYSE:NOV) builds and sells the equipment that makes oil and gas drilling possible. Because of that its business is tied to the rise and fall of energy prices as those prices dictate future activity leading to more, or less, business for National Oilwell Varco. And the plunge in crude oil prices over the past few months has dampened the industry's outlook, which has cut into National Oilwell Varco's business prospects.
That's why the stock is down about 40% from its 52-week high and selling for a pretty compelling bargain. That sale on its stock alone makes for a pretty compelling reason to buy it right now. However, if there's one lesson energy investors have learned over the past few months it's that cheap energy stocks can get a whole lot cheaper. That's why I'm exploring my options, so to speak, in hopes of adding shares of National Oilwell Varco to my own portfolio at an even better price that I can get today.
A look at the value
Before I get to the ins and outs of how I plan on buying shares in the future I first want to drill down a little deeper into the value of the business. As most savvy investors know, a company's value isn't the prices we pay for the stock but the multiple of that company's earnings. So, it matters not that the stock price is currently in the mid-$50 a share range.
Instead, what I'm interested in is the value of the business and this can be measured in several ways. The most common valuation multiple is the price to earnings, or P/E multiple, but that's not always the best method. That's why I also like to look at another common metric, which is a company's enterprise value to EBITDA ratio, or EV/EBITDA as this more accurately measures the underlying cash flow generated by the business. I also like to look at a few others like price to tangible book value and price to sales just to get a few other data points. I personally don't have a favorite valuation metric as I prefer to look at a basket of multiples as I don't feel like I get a full picture by looking at just one number. So, here's National Oilwell's valuation basket looking back over the past decade.
Here we see that the company's current valuation is much cheaper than it has been in years. However, the value isn't yet at its low for the decade, which happened the last time the price of oil plunged during the financial crisis. So, while today's value is good, it's not rock bottom yet.
I already have a decent amount of energy exposure in my portfolio so my personal preference would be to either buy the stock closer to the bottom, or not at all. That means that I need to wait to buy, however, I do have some options that I can use in the meantime.
Looking at all my options
As most investors know there are a couple different ways to buy a stock. We can buy it at the current market price, set a limit order and hope the stock falls to that price, or we can use options. I'm going with that third option, and in this case I chose to write put options in order to try and buy National Oilwell Varco's stock at a nice discount to its recent price, or make some decent money while trying.
Specifically, I wrote the August $50 puts and was paid just over $400 for my effort. What this will allow me to do is buy the stock for a net $46 per share in August if the stock is below $50 a share at that time. That's about a 12% discount to the price when I wrote the puts and about an 8% yield on my capital at risk. Said another way, in August I'll either buy the stock for about $46 per share or earn $400 worth of income for trying. That's a win-win outcome in my book.
National Oilwell Varco's stock has been hit by the sell-off in the price of oil. However, its valuation isn't yet tempting enough for me to want to buy it right now. That's why I'm using options to either buy the stock cheaper or make some money while trying. Its a great tool for investors to use to buy a stock a whole lot cheaper.
Matt DiLallo has the following options: short August 2015 $50 puts on National Oilwell Varco. The Motley Fool recommends National Oilwell Varco. The Motley Fool owns shares of National Oilwell Varco. Try any of our Foolish newsletter services free for 30 days. 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 Motley Fool has a disclosure policy.