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Known as the father of value investment, Benjamin Graham was an economist and a professional investor. Warren Buffett states that Graham is the second most influential person in his life after his father. Benjamin Graham is famous for his simple yet powerful estimation rules. In his famous book, Security Analysis (1962), Graham describes his valuation method as such:

Long Term Valuation = EPS x (8.5 + 2 x Estimated Earnings Growth)

While this formula gives practical information on the stock rankings, it does not account for interest rates or inflation. Realizing this limitation, in Renaissance of Value, Benjamin Franklin updates his formula using the corporate bond yields:

V = EPS x (8.5 + 2 x Estimated Earnings Growth) x (4.4 / AAA Corporate Bond Yield)

Note that this is a long-term valuation. It does not imply any target price estimate. Moreover, according to this valuation, companies that are currently loss-making are worth zero. However, the formula can still be used to calculate the margin of safety.

The percentage difference between the valuation price and current price gives us the margin of safety.

Margin of Safety = (Valuation – Price) / Valuation

Graham suggested choosing the undervalued stocks with the highest margin of safety. Warren Buffett explains the margin of safety as paying $70 for a stock with intrinsic value of $100. Graham is a value investor, and he also suggested choosing dividend stocks with positive earnings, strong balance sheets and reasonable P/E ratios. Therefore, I screened for the energy companies that pay regular dividends, reported positive earnings, have a P/E ratio lower than 20, and current ratio of greater than 1. Stock market data is retrieved from Zacks Investment Research, and corporate bond data is retrieved from Financial Forecast Center.

Applying the valuation formula to energy stocks we get the following:

Company Name

EPS

Estimated Growth Rate

Current Price

Fair Value

Margin of Safety

DIAMOND OFFSHOR (NYSE:DO)

6,87

16,00

74,11

233,72

68,29%

CIMAREX ENERGY (NYSE:XEC)

6,52

21,22

107,80

278,99

61,36%

SEADRILL (NYSE:SDRL)

2,71

15,26

35,48

88,83

60,06%

ALLIANCE RES (NASDAQ:ARLP)

6,68

10,00

73,29

159,92

54,17%

DEVON ENERGY (NYSE:DVN)

6,39

12,84

88,05

174,88

50,65%

NOBLE CORP (NYSE:NE)

3,06

10,77

44,10

77,21

42,89%

ALLIANCE HLDGS (NASDAQ:AHGP)

2,92

14,00

51,36

89,53

42,63%

ENSCO (NYSE:ESV)

3,78

10,50

55,23

93,67

41,04%

ROYAL DTCH SH-A (NYSE:RDS.A)

6,65

6,00

68,86

114,51

39,87%

NATL OILWELL (VOR)

4,09

13,67

76,05

123,13

38,24%

CHEVRON (NYSE:CVX)

9,45

5,61

99,93

156,54

36,16%

TECHNIP (OTCQX:TKPPY)

5,08

13,32

96,52

149,95

35,63%

STATOIL ASA-ADR (NYSE:STO)

2,77

4,00

26,43

38,39

31,16%

CONOCOPHILLIPS (NYSE:COP)

5,96

6,61

76,30

108,74

29,83%

HESS CORP (NYSE:HES)

5,31

8,55

80,18

114,19

29,78%

PETROBRAS-ADR (NYSE:PBR)

4,02

3,92

39,43

55,18

28,54%

ENI SPA-ADR (NYSE:E)

5,24

3,00

48,56

63,82

23,91%

TOTAL FINA SA (NYSE:TOT)

6,13

3,00

58,83

74,66

21,21%

OCCIDENTAL (NYSE:OXY)

5,66

8,88

98,75

124,85

20,91%

PIONEER SW EGY (PSE)

2,85

3,00

31,15

34,71

10,26%

NEXEN (NXY)

1,48

7,00

25,73

27,97

8,02%

WORLD FUEL (NYSE:INT)

2,43

5,00

38,54

37,76

-2,06%

SUNOCO (NYSE:SXL)

5,41

4,00

84,07

74,98

-12,12%

VALERO ENERGY (NYSE:VLO)

1,65

4,70

27,98

24,81

-12,78%

WILLIAMS PTNRS (NYSE:WPZ)

2,66

5,00

49,69

41,34

-20,21%

SUBURB PROPANE (NYSE:SPH)

3,43

3,00

55,57

41,78

-33,01%

MAGELLAN (NYSE:MMP)

3,10

4,00

57,77

42,97

-34,46%

MARATHON OIL (NYSE:MRO)

3,64

1,56

50,17

35,53

-41,21%

EV ENERGY PTNR (NASDAQ:EVEP)

2,42

2,00

43,37

25,41

-70,68%

7,78

18,86%

The average margin of safety is 18.86%. Diamond Offshore, Cimarex Energy, Seadrill, Alliance Resources, and Devon Energy have margin of safety values higher than 50%. Top companies in the list also have strong balance sheets, high-profitability ratios and pay impressive dividends. In the last ten years, Diamond increased dividends by 400% from $0.5 in 2000 to $2.375 in 2010. Seadrill and ARLP are among the top 5 energy stocks with great dividends. Devon, National Oil Well, and Chevron are among hedge funds’ favorite stocks. According to his latest 13F filings, George Soros increased his Cimarex position by 90%. Diamond Offshore and ConocoPhillips provide potential buying opportunities. Hess also offers an opportunity to buy on pullback.

Based on the current valuations, and high-safety margins, the current snapshot of the energy stocks looks promising. As oil prices are hovering around $100, it might be a nifty idea to invest in energy stocks. If Benjamin Graham were alive, he could have been bullish about energy stocks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: 27 Energy Stocks Benjamin Graham Would Like