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I suppose it can be truthfully said that Hope is the only universal liar who never loses his reputation for veracity.

Robert Ingersoll

Novice investors tend to base their decisions on yield alone; while it's okay to risk a small amount of one's capital using this strategy, betting the house is asking for trouble. Our picks (especially our favorite play) have to generally meet most of the criteria listed below.

We generally base our choice on the following factors:

Net income: it should be generally trending upwards for the past 3-4 years.

Total cash flow from operating activities: it also should be trending upwards for the past 3-4 years.

Current ratio: should be above 1

Interest coverage ratio: any value above 1.5 is okay, but we would aim for 2.5-3.00 as our starting range. The higher the number the better

Sales: they should generally be trending upwards for the past 3-4 years.

Levered free cash flow: This is the icing on the cake; if a company meets most of the above requirements and also has a positive levered free cash flow, it can generally be viewed as a good long term buy. Two examples are LEG and PG.

The following criteria apply only two dividend paying stocks and not to growth stocks that might not payout dividends:

Payout ratio: It should generally be below 100%, but a ratio below 70% is optimal. Payout ratios are not that important when it comes to MLPS/REITS, as they generally pay a majority of their cash flow as distributions; in the case of REITS, by law they have to pay out 90% of their cash flow as dividends. Payout ratios are calculated by dividing the dividend/distribution rate by the net income per share, and this is why the payout ratio for MLPs and REITS is often higher than 100%. The more important ratio to focus on is the cash flow per unit. If one focuses on the cash flow per unit, one will see that in most cases, it exceeds the distribution/dividend declared per unit/share.

Dividend growth rate: it should be at 5% or higher. A high yield with a low dividend growth rate is not good in the long run, but neither is a low dividend yield with a high growth rate; one needs to find an equilibrium here. And there are exceptions to this rule; some stocks appreciate rather rapidly and so a low dividend could be offset by the capital gains.

Five year dividend average: We generally aim for stocks that have a yield of 4.5% or higher. There are exceptions to this rule. Some stocks appreciate very fast, so even though the yield might be low, one can more than make up the difference through capital gains. One example is Jarden.

An early warning signal that the company could be in trouble is when the total cash flow generated from operating expenses is not enough to meet the dividend payments. This information can be gleaned by looking at the cash flow statement; this is readily available at yahoo finance. In the example below we used LEG and the data was obtained from yahoo finance.

The cash flow in this case was more than enough to easily cover all the dividend payments for all the above years; in this, the time period was from 2008-2010.

Many traders use other metrics and that is fine; we are just trying to provide a guideline. As you get better handle of the ratios explained below, you can create your own list of criteria.

Long-term debt-to-equity ratio is the total long-term debt divided by the total equity. The amount of long-term debt a company carries on its balance sheet is very important, for it indicates the amount of money a company owes that it doesn't expect to pay off in the next year. A balance sheet that illustrates that long-term debt has been decreasing for a few years is a sign that the company is doing well. When debt levels fall, and cash levels increase, the balance sheet is said to be improving, and vice versa. If a company has too much debt on its books, it could end up being overwhelmed with interest payments and risk having too little working capital which could in the worst case scenario lead to bankruptcy.

Operating cash flow is generally a better metric than earnings per share, because a company can show positive net earnings and still not be able to properly service its debt; the cash flow is what pays the bills.

The payout ratio tells us what portion of the profit is being returned to investors. A pay out ratio over 100% indicates that the company is paying out more money to shareholders then they are making; this situation cannot last forever. In general, if the company has a high operating cash flow and access to capital markets, they can keep this going on for a while. As companies usually only pay the portion of the debt that is coming due and not the whole debt, this technique/trick can technically be employed to maintain the dividend for sometime. If the payout ratio continues to increase, the situation warrants close monitoring as this cannot last forever; if your tolerance for risk is a low, look for similar companies with the same or higher yields, but with lower payout ratios. Individuals searching for other ideas might find this article to be of 5 Splendid Dividend-Increasing Stocks

Current Ratio is obtained by dividing the current assets by current liabilities. This ratio allows you to see if the company can pay its current debts without potentially jeopardizing their future earnings. Ideally the company should have a ratio of 1 or higher.

Price to free cash flow is obtained by dividing the share price by free cash flow per share. Higher ratios are associated with more expensive companies and vice versa; lower ratios are generally more attractive. If a company generated 400 million in cash flow and then spent 100 million on capital expenditure, then its free flow is $300 million. If the share price is 100 and the free cash flow per share are $5, then company trades at 20 times-free cash flow. This ratio is also useful, because it can be used as a comparison to the average within the industry; this gives you an idea of how the company you are interested in holds up to the other companies within the industry.

Interest coverage is usually calculated by dividing the earnings before interest and taxes for a period of 1 year by the interest expenses for the same time period. This ratio informs you of a company's ability to make its interest payments on its outstanding debt. Lower interest coverage ratios indicate that there is a larger debt burden on the company and vice versa. For example if a company has an interest ratio of 11.8, this means that it covers interest expenses 11.8 times with operating profits.

Price to tangible book is obtained by dividing share price by tangible book value per share. The ratio gives investors some idea of whether they are paying too much for what would be left over if the company were to declare bankruptcy immediately. In general, stocks that trade at higher price to tangible book value could leave investors facing a great percentage per share loss than those that trade at lower ratios. The price to tangible book value is theoretically the lowest possible price the stock would trade to. Additional key metrics are addressed in this article 5 Growth Plays; 4 Impressive And 1 Middle Of The Road

Canadian Natural Resources Limited (NYSE:CNQ) is our favourite play on this list for the following reason

  • It has a good 3 year total return of 75%
  • A strong five year dividend growth rate of 21.4%
  • A low payout ratio of 15% and an excellent five year payout ratio of only 11%
  • Net income has increased from $1.3 billion in 2009 to $2.67 in 2011.
  • EBITDA increased from $4.58 billion in 2009 to $7.6 billion in 2011.
  • Cash flow per share rose from $4.96 in 2009 to $5.65 in 2011, but it dropped a bit from $5.89 in 2010.
  • Sales surged from $9.82 billion in 2009 to $15.4 billion in 2011.
  • It sports a five year average ROE of 17%
  • It has a weak current and quick ratio of 0.69 and 0.55, but this is somewhat compensated for by the very strong interest coverage ratio of 16.5.
  • It has a five year sales growth average of 6.5%
  • A beta of 1.66 which makes it a good candidate for covered writes. Selling calls opens up an additional stream of income and it sort of converts a non dividend stock into a dividend-paying stock; the premium becomes the dividend.
  • It has a very strong operating cash flow of $6.25 billion.
  • A good long-term debt to equity ratio of 0.42
  • It sports a strong quarterly revenue growth rate of 25%
  • An EPS growth rate of 41%
  • Zacks projects the EPS to increase from $2.07 in 2011 to $3.17 in 2012 and to $3.60 in 2013.
  • $100K invested for 10 years would have grown to $1.2 million

Company : Canadian Natural Resources Limited

Levered Free Cash Flow = -418.43M

Basic Key ratios

  1. Percentage Held by Insiders = 5
  2. Market Cap ($mil) = 36918

Growth

  1. Net Income ($mil) 12/2011 = 2675
  2. Net Income ($mil) 12/2010 = 1655
  3. Net Income ($mil) 12/2009 = 1391
  4. 12months Net Income this Quarterly/ 12months Net Income 4Q's ago = 62.68
  5. Quarterly Net Income this Quarterly/ same Quarter year ago = 294.61
  1. EBITDA ($mil) 12/2011 = 7690
  2. EBITDA ($mil) 12/2010 = 7163
  3. EBITDA ($mil) 12/2009 = 4581
  4. Net Income Reported Quarterlytr ($mil) = 831
  5. Annual Net Income this Yr/ Net Income last Yr = 61.66
  6. Cash Flow ($/share) 12/2011 = 5.65
  7. Cash Flow ($/share) 12/2010 = 5.89
  8. Cash Flow ($/share) 12/2009 = 4.96
  1. Sales ($mil) 12/2011 = 15483
  2. Sales ($mil) 12/2010 = 14697
  3. Sales ($mil) 12/2009 = 9820
  1. Annual EPS before NRI 12/2007 = 2.09
  2. Annual EPS before NRI 12/2008 = 2.51
  3. Annual EPS before NRI 12/2009 = 2.68
  4. Annual EPS before NRI 12/2010 = 2.3
  5. Annual EPS before NRI 12/2011 = 2.31

Dividend history

  1. Dividend Yield = 1.25
  2. Dividend Yield 5 Year Average = 0.8%
  3. Annual Dividend 12/2011 = 0.37
  4. Annual Dividend 12/2010 = 0.29
  5. Forward Yield = 1.25
  6. Dividend 5 year Growth = 21.42%
  1. Dividend sustainability
  2. Payout Ratio 06/2011 = 0.15
  3. Payout Ratio 5 Year Average 06/2011 = 0.11
  4. Change in Payout Ratio = 0.04

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -35.35
  2. Next 3-5 Year Estimate EPS Growth rate = 8
  3. EPS Growth Quarterly(1)/Q(-3) = 1-122.22
  4. ROE 5 Year Average 06/2011 = 17.14
  5. Return on Investment 06/2011 = 8.64
  6. Debt/Total Cap 5 Year Average 06/2011 = 37.36
  1. Current Ratio 06/2011 = 0.69
  2. Current Ratio 5 Year Average = 0.75
  3. Quick Ratio = 0.55
  4. Cash Ratio = 0.04
  5. Interest Coverage Quarterly = 16.52

Valuation

  1. Book Value Quarterly = 21.16
  2. Price/ Book = 1.59
  3. Price/ Cash Flow = 5.96
  4. Price/ Sales = 2.46
  5. EV/EBITDA 12 Mo = 6.31

Notes

This is a great long term play

Company : Enerplus Corp (NYSE:ERF)

Levered Free Cash Flow = -317.79M

Basic Key ratios

Market Cap ($mil) = 4468

Growth

  1. Net Income ($mil) 12/2011 = 111
  2. Net Income ($mil) 12/2010 = 123
  3. Net Income ($mil) 12/2009 = 78
  4. 12months Net Income this Quarterly/ 12months Net Income 4Q's ago = -6.82
  5. Quarterly Net Income this Quarterly/ same Quarter year ago = -29666.11
  1. EBITDA ($mil) 12/2011 = 630
  2. EBITDA ($mil) 12/2010 = 712
  3. EBITDA ($mil) 12/2009 = 618
  4. Net Income Reported Quarterlytr ($mil) = -300
  5. Annual Net Income this Yr/ Net Income last Yr = -10.27
  6. Cash Flow ($/share) 12/2011 = 1.36
  7. Cash Flow ($/share) 12/2010 = 4.28
  8. Cash Flow ($/share) 12/2009 = 3.68
  1. Sales ($mil) 12/2011 = 1095
  2. Sales ($mil) 12/2010 = 1346
  3. Sales ($mil) 12/2009 = 1108
  1. Annual EPS before NRI 12/2007 = 2.49
  2. Annual EPS before NRI 12/2008 = 5.22
  3. Annual EPS before NRI 12/2009 = N/A
  4. Annual EPS before NRI 12/2010 = 0.72
  5. Annual EPS before NRI 12/2011 = -1.07

Dividend history

  1. Dividend Yield = 9.47
  2. Dividend Yield 5 Year Average =9.9%
  3. Annual Dividend 12/2011 = 2.2
  4. Annual Dividend 12/2010 = 2.08
  5. Forward Yield = 9.47
  6. Dividend 5 year Growth =-19.9%

Dividend sustainability

  1. Payout Ratio 06/2011 = 4.08
  2. Payout Ratio 5 Year Average 06/2011 = 2
  3. Change in Payout Ratio = 2.07

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -32.17
  2. EPS Growth Quarterly(1)/Q(-3) = -266
  3. ROE 5 Year Average 06/2011 = 9.06
  4. Return on Investment 06/2011 = 2.3
  5. Debt/Total Cap 5 Year Average 06/2011 = 16.15
  1. Current Ratio 06/2011 = 0.27
  2. Current Ratio 5 Year Average = 0.58
  3. Quick Ratio = 0.27
  4. Cash Ratio = 0.04
  5. Interest Coverage Quarterly = 15.84
  1. Valuation
  1. Book Value Quarterly = 18.33
  2. Price/ Book = 1.25
  3. Price/ Cash Flow = 16.82
  4. Price/ Sales = 4.02
  5. EV/EBITDA 12 Mo = 8.47

Notes

Net income, cash flow per share, sales and EBITDA all declined from 2010. It also sports a weak current and quick ratio and for this reason we would have to place it under the category of "average". In addition its five year dividend growth rate has turned negative.

Company : Pengrowth Egy (NYSE:PGH)

Levered Free Cash Flow = 8.54M

Growth

  1. Net Income ($mil) 12/2011 = 86
  2. Net Income ($mil) 12/2010 = 224
  3. Net Income ($mil) 12/2009 = 75
  4. 12months Net Income this Quarterly/ 12months Net Income 4Q's ago = -60.67
  5. Quarterly Net Income this Quarterly/ same Quarter year ago = -553.77
  1. EBITDA ($mil) 12/2011 = 644
  2. EBITDA ($mil) 12/2010 = 799
  3. EBITDA ($mil) 12/2009 = 582
  4. Net Income Reported Quarterlytr ($mil) = -9
  5. Annual Net Income this Yr/ Net Income last Yr = -61.74
  6. Cash Flow ($/share) 12/2011 = 1.59
  7. Cash Flow ($/share) 12/2010 = 2.45
  8. Cash Flow ($/share) 12/2009 = 2.23
  1. Sales ($mil) 12/2011 = 1460
  2. Sales ($mil) 12/2010 = 1392
  3. Sales ($mil) 12/2009 = 1305
  1. Annual EPS before NRI 12/2007 = -0.3
  2. Annual EPS before NRI 12/2008 = 1.29
  3. Annual EPS before NRI 12/2009 = 0.31
  4. Annual EPS before NRI 12/2010 = 0.78
  5. Annual EPS before NRI 12/2011 = 0.34

Dividend history

  1. Dividend Yield = 8.48
  2. Dividend Yield 5 Year Average =12%
  3. Annual Dividend 12/2011 = 0.86
  4. Annual Dividend 12/2010 = 0.74
  5. Forward Yield = 8.48
  6. Dividend 5 year Growth =-27%

Dividend sustainability

  1. Payout Ratio 06/2011 = 2.27
  2. Payout Ratio 5 Year Average 06/2011 = 1.63
  3. Change in Payout Ratio = 0.64

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -33.3
  2. EPS Growth Quarterly(1)/Q(-3) = 6-100.00
  3. ROE 5 Year Average 06/2011 = 9.83
  4. Return on Investment 06/2011 = 2.72
  5. Debt/Total Cap 5 Year Average 06/2011 = 30.21
  1. Current Ratio 06/2011 = 0.62
  2. Current Ratio 5 Year Average = 0.63
  3. Quick Ratio = 0.62
  4. Cash Ratio = 0.1
  5. Interest Coverage Quarterly = 1.81

Valuation

  1. Book Value Quarterly = 9.42
  2. Price/ Book = 1.05
  3. Price/ Cash Flow = 6.25
  4. Price/ Sales = 2.42
  5. EV/EBITDA 12 Mo = 7.1

Notes

Net income, EBITDA, and cash flow per share have taken hits. It has a 5 year EPS growth rate of -29%, weak quick and current ratios, a 5 year dividend growth rate of -27% and a negative levered free cash flow. Hence it would fall under the category of "average"

Company : Penn West Egy (NYSE:PWE)

Levered Free Cash Flow = -335.28M

Growth

  1. Net Income ($mil) 12/2011 = 646
  2. Net Income ($mil) 12/2010 = 219
  3. Net Income ($mil) 12/2009 = -127
  4. 12months Net Income this Quarterly/ 12months Net Income 4Q's ago = 195.14
  5. Quarterly Net Income this Quarterly/ same Quarter year ago = -192.44
  1. EBITDA ($mil) 12/2011 = 1588
  2. EBITDA ($mil) 12/2010 = 1209
  3. EBITDA ($mil) 12/2009 = 910
  4. Net Income Reported Quarterlytr ($mil) = -62
  5. Annual Net Income this Yr/ Net Income last Yr = 194.23
  6. Cash Flow ($/share) 12/2011 = 3.51
  7. Cash Flow ($/share) 12/2010 = 3.35
  8. Cash Flow ($/share) 12/2009 = 2.95
  1. Sales ($mil) 12/2011 = 3678
  2. Sales ($mil) 12/2010 = 3092
  3. Sales ($mil) 12/2009 = 2516
  1. Annual EPS before NRI 12/2007 = 0.68
  2. Annual EPS before NRI 12/2008 = 1.38
  3. Annual EPS before NRI 12/2009 = -0.31
  4. Annual EPS before NRI 12/2010 = 0.52
  5. Annual EPS before NRI 12/2011 = 1.03

Dividend history

  1. Dividend Yield = 5.33
  2. Dividend Yield 5 Year Average =13%
  3. Annual Dividend 12/2011 = 1.1
  4. Annual Dividend 12/2010 = 1.5
  5. Forward Yield = 5.33
  6. 5 year dividend growth rate= 6.5%
  1. Dividend sustainability
  2. Payout Ratio 06/2011 = 0.81
  3. Payout Ratio 5 Year Average 06/2011 = 2.81
  4. Change in Payout Ratio = -2

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -31.64
  2. EPS Growth Quarterly(1)/Q(-3) = -103
  3. ROE 5 Year Average 06/2011 = 6.31
  4. Return on Investment 06/2011 = 5.08
  5. Debt/Total Cap 5 Year Average 06/2011 = 28.32
  1. Current Ratio 06/2011 = 0.47
  2. Current Ratio 5 Year Average = 0.72
  3. Quick Ratio = 0.47
  4. Cash Ratio = 0.11
  5. Interest Coverage =3.20

Valuation

  1. Book Value Quarterly = 19.47
  2. Price/ Book = 1.04
  3. Price/ Cash Flow = 5.77
  4. Price/ Sales = 2.98
  5. EV/EBITDA 12 Mo = 8.09

Notes

This company just makes it to the "good" category. Its 3 year dividend growth rate has turned negative but on the positive side, net income, EBITDA, cash flow per share, and sales have increased for the past 3 years.

Company : Nexen Inc (NXY)

Levered Free Cash Flow = 1.25B

Basic Key ratios

  1. Percentage Held by Insiders = 0.17
  2. Market Cap ($mil) = 9891

Growth

  1. Net Income ($mil) 12/2011 = 705
  2. Net Income ($mil) 12/2010 = 1162
  3. Net Income ($mil) 12/2009 = 489
  4. 12months Net Income this Quarterly/ 12months Net Income 4Q's ago = -31.68
  5. Quarterly Net Income this Quarterly/ same Quarter year ago = -79.81
  1. EBITDA ($mil) 12/2011 = 3680
  2. EBITDA ($mil) 12/2010 = 3008
  3. EBITDA ($mil) 12/2009 = 993
  4. Net Income Reported Quarterlytr ($mil) = 43
  5. Annual Net Income this Yr/ Net Income last Yr = -39.31
  6. Cash Flow ($/share) 12/2011 = 5.19
  7. Cash Flow ($/share) 12/2010 = 4.13
  8. Cash Flow ($/share) 12/2009 = 0.98
  1. Sales ($mil) 12/2011 = 6483
  2. Sales ($mil) 12/2010 = 5657
  3. Sales ($mil) 12/2009 = 5556
  1. Annual EPS before NRI 12/2007 = 2.46
  2. Annual EPS before NRI 12/2008 = 3.55
  3. Annual EPS before NRI 12/2009 = 0.97
  4. Annual EPS before NRI 12/2010 = 1.05
  5. Annual EPS before NRI 12/2011 = 1.47

Dividend history

  1. Dividend Yield = 1.07
  2. Dividend Yield 5 Year Average =0.8%
  3. Annual Dividend 12/2011 = 0.2
  4. Annual Dividend 12/2010 = 0.19
  5. Forward Yield = 1.07
  6. 5 year dividend growth rate= 21.7%
  1. Dividend sustainability
  1. Payout Ratio 06/2011 = 0.14
  2. Payout Ratio 5 Year Average 06/2011 = 0.11
  3. Change in Payout Ratio = 0.03

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -28.15
  2. Next 3-5 Year Estimate EPS Growth rate = 7
  3. EPS Growth Quarterly(1)/Q(-3) = -170
  4. ROE 5 Year Average 06/2011 = 17.26
  5. Return on Investment 06/2011 = 6.3
  6. Debt/Total Cap 5 Year Average 06/2011 = 43.63
  1. Current Ratio 06/2011 = 1.08
  2. Current Ratio 5 Year Average = 1.36
  3. Quick Ratio = 0.98
  4. Cash Ratio = 0.33
  5. Interest Coverage =7.9%

Valuation

  1. Book Value Quarterly = 16.05
  2. Price/ Book = 1.17
  3. Price/ Cash Flow = 3.61
  4. Price/ Sales = 1.36
  5. EV/EBITDA 12 Mo = 3.65

Notes

It would fall under the category of "good".

EPS, EPS surprise, broker recommendations, and price and consensus charts sourced from zacks.com. Earning's estimates and growth rate charts sourced from dailyfinance.com. Free cash flow yield, income from cont operations, and revenue growth sourced from Ycharts.com.

Disclaimer: This list of stocks is meant to serve as a starting point. Please do not treat this as a buying list. It is imperative that you do your due diligence and then determine if any of the above plays meet with your risk tolerance levels. The Latin maxim caveat emptor applies-let the buyer beware

Source: A Look At 5 Stock Picks