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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 Chevron Corp. (NYSE:CVX) 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 Chevron were very encouraging. Keep in mind, however, that this is just one of the many ways to analyze a stock.

Chevron is now offering a 3% dividend yield, and many Wall Street analysts are upgrading the stock's price target ahead of the Q1 2013 earnings report releases for big oil stocks. This article gives further proof to show why Chevron is a great addition to your portfolio.

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: Chevron annual reports.

Operating income divided by net sales is the calculation used to obtain the operating profit margin. The operating profit margin has beaten the industry average 4 out of 5 times in the last 5 years. Furthermore, the operating profit margin has jumped back over 20% in 2012, which is a very encouraging sign.

Net income divided by net sales gives you the net profit margin. The net profit margin has beaten the industry average 3 out of 4 times in the last 5 years. It is heading back up to the 20% mark and that is really good. Chevron's operating profit margin and net profit margin are much higher than its closest rivals over the last 3 years: Exxon Mobil (NYSE:XOM), BP (NYSE:BP), TOTAL S.A. (NYSE:TOT) and Royal Dutch Shell (NYSE:RDS.A).

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The Return on Investment ratios for Chevron aren't as impressive as Exxon's, though. Nonetheless when compared to the industry as a whole, Chevron is in the top echelon. That should be all investors should really be concerned about.

The Return on Equity [ROE] ratio is arrived at by dividing the net income by the shareholders' equity. The ROE has increased from 2010 to 2011, but then decreased from 2011 to 2012. The 2012 ROE is a far cry from the 2008 level.

As for the Return on Assets [ROA], it is obtained by dividing the net income by the total assets. The ROA has consistently beaten the industry average over the last 5 years.

Income Statement:

Chevron's income statement numbers is similar to other firms in the oil and gas industry, but Exxon is an outlier. Exxon's income statement numbers are far superior to its closest competitors.

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Note: U.S. dollar in millions.

Balance Sheet:

Chevron has a fairly 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, Chevron has the upper hand in this area as well when compared to its competitors, with only Exxon having better figures. Chevron appears to be an excellent substitute for XOM, which is the proxy for the oil and gas industry.

Note: U.S. dollar in millions.

Cash Flows

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, Chevron's free cash flow has remained positive with the exception of 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.

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Note: U.S. dollar in millions.

The positive cash flow is an indication that Chevron has enough cash to develop new products, make acquisitions, pay dividends and reduce debt. These free cash flow levels are comparable to BP, RDS.A and TOT, but they are half the value of XOM's free cash flows.

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 Chevron's cash flow margin is high (higher than Exxon), it can continue operating without any foreseeable cash problems.

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Note: U.S. dollar in millions.

Conclusion: Ignore the fact that Hedge Funds are selling CVX

CVX is currently trading at $120.29 and it has very attractive valuations. The profitability ratios are sound and even the price action over the long term as seen in the 3-month, 6-month, 1-year and 5-year charts is encouraging for bulls. The smartest money out there has definitely missed a long idea in Chevron's case.

The stock is up 11.04% over the last 3 months and it is very close to its 52-week high of $121.56. The Organization for Economic Cooperation and Development (OECD) came out 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.

It doesn't hurt that Chevron continues to explore for new sources of oil with tremendous success. Major integrated energy companies are always a great investment idea.

All material is sourced from Morningstar and MSN Money.

Source: Chevron Corporation: Profitability Analysis