GeoResources Is Highly Overvalued

Apr. 1.12 | About: GeoResources, Inc. (GEOI)

We discussed in our previous article the price evolution of Newfield Exploration Company (NYSE:NFX) and found that its current share price is highly undervalued relative to the fundamental price level. The latter is defined by our pricing model based on share price decomposition into a weighted sum of individual consumer price indices (alternatively PPIs). Here we present an opposite case - GeoResources (NYSE: GEOI), "an independent oil and gas company, which engages in the acquisition, re-engineering, development, and exploration of oil and gas reserves in the Southwest, Gulf Coast, and the Williston Basin areas of the United States." (Yahoo Finance) This company with capitalization of ~$850M is highly overvalued relative to the predicted (fundamental) price.

Our pricing concept and approach have been discussed many times. For example, articles [1, 2, 3] were devoted to ConocoPhillips (NYSE: COP), which provides an excellent benchmark and general explanation of the quantitative definition of fundamental price. The measured COP price is accurately described by a linear combination of two consumer price indices, the core and headline ones. The headline CPI plays the role of that part of the overall energy price which is directly related to the share price. The agreement is so good that it is difficult to deny that energy (in one form or another) drives the evolution of ConocoPhillips.

The best fit (LSQ) model for GEOI share is the following:

GEOI(t) = -2.59CC(t-0) + 0.14E(t-0) + 11.63(t-2000) + 321.12 ; sterr=$2.87

where GEOI(t) is the share price in U.S. dollars at time t, CC is the core CPI, and E is the consumer price index of energy. The model standard error is only $2.87 for the period between July 2003 and March 2012. The model also allows both CPIs to lead the share price by 0 to 12 months. However, the best lags are both zero. The index of energy drives the price up, and the core CPI affects the price negatively. Figures 1 and 2 depict the observed and predicted monthly prices and the residual model error, respectively.

The overall agreement is good but the model residual has several spikes; the most recent has been observed since the second half of 2011. Currently, the error is +$6.5, which is an extremely high residual for GEOI. The same positive residual was observed a year ago. It had returned quickly to the predicted curve and then was followed by a negative residual of approximately the same amplitude. Therefore, the evolution of GEOI price is characterized by very high volatility likely associated with its size; smaller companies are subject to higher risks. At the same time, the COP model proves that the predicted price might play the role of "fundamental" price. Since GEOI is much smaller than COP, one can consider the current positive excursion as a short-term deviation. Then the GEOI price is highly overvalued.

Thus, we expect the GEOI price to fall to the level of $25 per share in the near future, i.e. we expect GEOI to return to its fundamental price.

Figure 1. The observed and predicted monthly closing prices for GEOI between July 2003 and March 2012.

Figure 2. The model residual error.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in COP over the next 72 hours.