I have been analyzing big oil stocks that offer a good return on investment for a value investor. My analysis here is based on the profitability ratios in the financial statements of Exxon Mobil (XOM) over the last 5 years.
When a firm has strong profitability ratios, it portrays to an investor that it provides a good return on his or her investment. The profitability numbers that I came across for Exxon were very encouraging. Keep in mind, however, that this is just one of the many ways to analyze a stock.
Recently, Exxon Mobil was surpassed as the world's largest publicly-traded oil company by Russia's Rosneft (OJSCY.OB). Oil and gas companies keep the world running and will do so for many more years. There are none better than Exxon which manages hundreds of billions of dollars of capital and generates excellent returns for its investors.
A profitability analysis of a company involves looking at a class of financial metrics to determine a firm's capacity to generate profitable sales from the resources it has. Typically, higher ratio numbers translate to a higher investment value for the firm.
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Source: Exxon Mobil annual reports.
Operating income divided by net sales is the calculation used to obtain the operating profit margin. The operating margin has beaten the industry average 4 out of 5 times in the last 5 years. Furthermore, the operating margin has gotten closer to 20% in 2012 which is a very encouraging sign. Still, Chevron Corporation's (CVX) operating profit margin is higher in the last 3 years. The same trend can be seen when comparing net profit margins for the two companies.
Net income divided by net sales gives you the net profit margin. The net profit margin has also beaten the industry average 4 out of 5 times in the last 5 years. It isn't anywhere near the 20% mark, but these numbers are high in the oil and gas industry.
For investors, it is the ROE values that will matter and XOM is way ahead in that area, reporting a staggering 40% back in 2008. Exxon's closest rivals like Chevron and BP PLC (BP) have much lower values.
The Return on Equity [ROE] ratio is arrived at by dividing the net income by the shareholders' equity. The ROE has been on an uptrend since 2009. Yet, it is nowhere near the 2008 level.
As for the Return on Assets [ROA], it is obtained by dividing the net income by the total assets. Even the ROA has been considerably higher than the industry average over the last 5 years.
Exxon Mobil has an impressive income statement, as is shown in the table below. Again, the income statement numbers are far superior to its closest rivals, Chevron and BP. Exxon's figures for net income, sales and other operating revenues and income before interest and income tax expense are double what it is for Chevron, BP and even Royal Dutch Shell (RDS.A).
Exxon has a strong balance sheet. The numbers used to arrive at the profitability ratios listed in the 'Return on Investment' table are shown in the table below.
As you might have expected, Exxon Mobil has the upper hand in this area as well when compared to its competitors. Exxon is very, very good at what it does.
The trend that can be seen across the board is that big oil stocks have continued to grow their assets rapidly over the past 5 years.
Note: U.S. dollar in millions.
10. Free Cash Flow = Operating Cash Flow - Capital Expenditure
Free cash flow is a measure of financial performance that must be taken into account. It is calculated as operating cash flow minus capital expenditures. Free cash flow [FCF] represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.
Over the past five years, Exxon's free cash flow has remained positive except for 2009. Still, it must be noted that negative free cash flow is not necessarily a bad thing. When the free cash flow is negative, it could be an indication that a firm is making large investments. This could work out very well for a company in the future if these investments earn a high return.
The extremely high positive cash flow is a sign that Exxon has enough cash to make acquisitions, pay dividends and reduce debt.
11. Cash Flow Margin = Cash Flow from Operating Activities / Total Sales
A high cash flow margin can indicate that a company is efficient at converting sales to cash, and may also be an indication of high earnings quality.
On the other hand, a low or negative cash flow margin means that a firm will have to borrow money or require a large influx of outside capital in order to keep on operating.
As Exxon's cash flow margin is good, it can continue operating without any foreseeable cash problems.
Conclusion: XOM is a great long idea
XOM is currently trading at $90.13 and it has very attractive valuations. The profitability ratios are extremely good and even the price action is encouraging for bulls.
The stock is up 3.5% over the last 3 months and its getting mighty close to its 52-week high of $93.67. The Organisation for Economic Co-operation and Development (OECD) came up with a report that outlined how India and China will emerge to eventually become larger economies than the United States. In China's case, it will happen in the next 5 years and for India it will take another 40 years.
The United States will also continue to grow with the GDP per capita expected to double over the next 50 years from about $43,000 right now to $92,000 in 2060 according to the same OECD report. These higher incomes and living standards will increase the demand for energy.
Oil stocks are the place to invest in especially if you're in your twenties. It doesn't hurt that Exxon offers a juicy dividend and it recently paid out a quarterly dividend of $0.57 per share on March 1.