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During this analysis I will compare several aspects of oil and gas companies with regard to fundamental elements of financial strength. I have incorporated multiple components of both value and growth investors.

To strategically add companies to my portfolio I use a weighted analysis of cash flow, liquidity, profitability, return, size and valuation. I chose ten metrics that I deem crucial to my portfolio. They are: Current Ratio, Long-term Debt to Assets, Cash Flow per Share, Net Profit Margin, Dividends, Market Capitalization, Shares Outstanding, Price to Cash Flow, Free Cash Flow to Operating Cash Flow, Operating Cash Flow to Sales. I have noted each of the weights of these metrics in parenthesis.

In this first article, I will detail the elements I plan to analyze and explain their importance in making sound investment decisions.

Liquidity

Current Ratio (4%).

  • The current ratio demonstrates the company's ability to meet short-term obligations through the calculation of current assets/current liabilities. A higher current ratio indicates the company is more liquid.

Long-term Debt to Assets (5%).

  • Generally, it behooves the investor to know the long-term debt to asset ratio across an industry. This metric shows the ability of a firm to meet its financial obligations.

Profitability

Cash Flow per Share (10%).

  • Cash flow is one of the most important factors in determining the financial strength of an investment. The cash flow allows investors to determine the efficiency of the company's business model. This metric is more reliable than earnings per share, as EPS can be more easily be manipulated.

Net Profit Margin (6%).

  • Net profit margin is a solid metric to determine the efficiency of a company after accounting for taxes.

Return

Dividend (5%).

  • Dividend represents the payback to shareholders. Personally, I prefer dividends greater than 2.5%.

Size

Market Capitalization (1%).

  • Generally, companies with larger market capitalization are more liquid to trade. Therefore, an investor will be able to easily buy and sell shares as necessary.
  • Additionally, companies with large market capitalization are more stable companies, as they have grown sales for multiple years.

Shares Outstanding (1%).

  • Knowing the amount of shares outstanding could be interpreted to analyze the price stability of a stock. Meaning, the more shares that are outstanding, there would need to be more shares traded to create volatility in price movement.

Valuation

Price to cash flow (25%).

  • Similar to the P/E ratio, however, cash flow is harder to manipulate than earnings. Therefore, this metric can be used with P/E ratio to determine the valuation of a company. The lower ratio, the better entry point for stock purchases. Generally, this means the stock is priced lower when compared to the cash flow it is generating.

Cash Flow

Free Cash Flow to Operating Cash Flow (20%).

  • Free cash flow is the operating cash flow less capital expenditures. Generally, it is better to analyze the value and profitability of a company based on its cash flow as opposed to earnings. This is because earnings have the potential to be manipulated or skewed.
  • Free cash flow to operating cash flow indicates the financial strength of the company. The free cash flow can be used to grow the business beyond its normal business operations.

Operating Cash Flow to Sales (23%).

  • Operating cash flow is the cash that is generated through a company's ordinary business operations. This metric is crucial because it identifies whether a company is generating enough cash to maintain operations and grow the business.
  • Operating cash flow to sales ratio gives investors a percentage visualization regarding a company's effectiveness in converting sales to cash.

As you can see I have placed heavy emphasis on the cash flows of a company. The percentage breakdowns are as follows:

  • Liquidity: 9%
  • Profitability: 16%
  • Return: 5%
  • Size: 2%
  • Valuation: 25%
  • Cash Flow: 43%

To perform my analysis, I rank each of the companies against one another based on their performance of each of these metrics. Therefore, if I rank five companies, the strongest score would be five, by virtue of receiving a five rating in every category.

Granted, no methodology is perfect. The weighted system I use meets my investment strategy and risk profile. Generally, I plan to hold stocks for 3-5 years. Preferably, I would like to hold them into retirement around the 20-30 year time horizon.

For purposes of this article, I have analyzed five companies in the oil and gas industry with regard to their full year 2012 information. The reason I analyzed 2012 financial information is so that I can easily compare it to full year 2013 this quarter. Going forward, I would like to conduct this type of analysis on a quarterly basis. The companies I chose are: BP p.l.c. (NYSE:BP), ConocoPhillips (NYSE:COP), Chevron (NYSE:CVX), Royal Dutch Shell (NYSE:RDS.A) and Exxon Mobil (NYSE:XOM). Here is how each of them performed:

  • BP: 1.61
  • COP: 3.79
  • CVX: 3.32
  • RDS.A: 3.52
  • XOM: 2.76

The data used for this analysis was retrieved on Sunday January 5, 2014 from the Google Finance, Morningstar and Nasdaq websites.

Weight

BP

COP

CVX

RDS.A

XOM

Market Capitalization

1.0%

$150B

2

$86B

1

$239B

4

$222B

3

$435B

5

CF/Sh

10.0%

11.82

1

12.8

4

19.77

5

12.55

3

11.9

2

Shares Outstanding

1.0%

3.161B

4

1.24B

1

1.93B

2

3.14B

3

4.40B

5

Dividend %

5.0%

4.57%

4

3.95%

3

3.22%

2

5.09%

5

2.53%

1

Current Ratio

4.0%

1.42

4

1.38

3

1.6

5

1.14

2

0.84

1

LTD to Assets

5.0%

12.91

2

17.73

1

5.18

3

8.3

4

2.38

5

Net Profit Margin

6.0%

3.04

1

12.07

5

11.21

4

5.75

2

10.52

3

P/CF

25.0%

6.9

2

5.4

4

6.4

3

5

5

9.3

1

OCF/Sales (CF Margin)

23.0%

5%

1

26%

5

16%

4

10%

2

11%

3

FCF/OCF

20.0%

-12%

1

8%

3

1%

2

18%

4

26%

5

100.00%

Liquidity

9.0%

BP

1.61

Profitability

16.0%

COP

3.79

Return

5.0%

CVX

3.32

Size

2.0%

RDS.A

3.52

Valuation

25.0%

XOM

2.76

Cash Flow

43.0%

100.0%

Based on my analysis ConocoPhillips would be the strongest oil and gas company to add to my oil and gas portfolio. As explained earlier, I place the most emphasis on cash flow. As you can see COP places very high with metrics that are based on cash flow. Thereby, leading to its strong rating.

Disclaimer: Please note this is not investment advice, the ideas expressed in this article are solely my opinions.

Source: ConocoPhillips' Strong Cash Flow Blows Away Competition