**Introduction**

**Baker Hughes** (BHI), **Halliburton** (NYSE:HAL) and **Schlumberger** (NYSE:SLB) are leading suppliers of oilfield services, products, technology and other systems to the worldwide oil and natural gas industry. These companies are investing billions of dollars in an effort to grow oil and gas production, and they are top companies in the industry. If you are considering buying stock in the oil and gas industry, you might find it hard to decide which of these three you will go with. It is good then to consider valuations prepared for these companies.

Concerning the Investment Valuation of these companies, let's look at the margin of safety of Benjamin Graham. These three companies have passed the requirement of Graham of being at least 40-50% below the true values of the stocks - good Buys. Let us find out which stock among these three companies is the best candidate for a Buy. The historical five-year financial data was gathered and evaluated to come up with the answers. Today, we will compare these three oil and gas companies and track the latest investment status for each. Which Is The Winning Bet For Now?

**Deep Finance Expertise**

The investment valuation of BHI, HAL and SLB will be based on the Pricing Model, which is a very simple and easy way to value a company for business valuation purposes. This valuation adopts the investment style of Benjamin Graham, the father of value investing.

The essence of Graham's Value Investing is that any investment should be worth substantially more than an investor has to pay for it. He believed in thorough analysis, which we call fundamental analysis. He looks for companies with strong balance sheets or those with little debt, above-average profit margins and ample cash flow. His valuation seeks out undervalued companies with stock prices that are temporarily down but with fundamentals that are sound in the long run. His philosophy was to buy wisely when prices fall and to sell wisely when the prices rise substantially.

My basis of valuation is the company's last five years of financial records - the balance sheet, income statement and cash flow statement. In my valuation, first I will calculate the discounted cash flow, enterprise value and the margin of safety. The relative method was considered as well. Now, let us walk, step by step...

**1. Discounted Cash Flow Analysis**

Today, I am going to share with you the discounted cash flow analysis, which is based upon the five-year historical financial data of BHI-HAL-SLB to arrive at the projected cash inflows. The discounted cash flow is one way to decide if the investment is worthwhile. It is the expected cash that the company can generate. It does not predict the future, but it uses the historical data to project a future financial picture so that readers may understand the parameters that are not so easily understood without using a spreadsheet. The table below is the summary I gathered from the spreadsheet.

The basis for the computation of the Present and Future Values was the capitalization rate of 15 percent. The average return on equity (ROE) was used for BHI, while the average return on investment (ROI) was used for HAL and SLB. In addition, the rate was computed at an ROI less the average percentage of dividends from 2008.

Going forward, the calculated present value of the equity was $18, $18 and $38.4 billion at a rate of $41.08, $19.47 and $28.67 per share for BHI, HAL and SLB, respectively. Furthermore, the future value of equity was $24.9, $31 and $62 billion at a rate of $56.41, $33.56 and $47.98 per share for BHI, HAL and SLB, respectively. The future value is equal to the present value and this means having a choice of taking the amount of the present value or wait for the five time periods to attain the future value. If you take the present value today, you will have a chance to reinvest the money with the same rate over equal time periods and will end up having more than the present value.

Now, let us walk a little further and see what's up with the net income. The present value of the net income was $1.3, $2.8 and $6 billion for BHI, HAL and SLB, respectively. Furthermore, the fifth-year income was $2.7, $5.5 and $12 billion at $6.12, $5.97 and $9.03 per share on BHI, HAL and SLB, respectively.

**2. The Enterprise Value Approach**

The concept of enterprise value is to calculate what it would cost to purchase an entire business. The enterprise value is the present value of the entire company. It measures the value of the productive assets that produced its product or services, and both the equity capital (market capitalization) and debt capital. Market capitalization is the total value of the company's equity shares. In essence, it is a company's theoretical takeover price because the buyer would have to buy all of the stock and pay off the existing debt, pocketing any remaining cash. This gives the buyer solid ground for making an offer.

The formula for Enterprise Value:

**Enterprise Value = Market Capitalization + Total Debt - (Cash and Cash Equivalent + Short Term Investment)**

**Note**: *Market Capitalization = Market Price x Number of shares outstanding*

*Total Debt = Market value of Short Term Debt + Market value of Long Term Debt*

Going forward, let us walk through the table below for the calculation of the enterprise values:

To give you insights on market capitalization, BHI has had an erratic movement - trending at an average of 22%. It showed an increase of 113% from 2008. On the other hand, the market capitalization of HAL was increasing at an average rate of 24% for the same time period. SLB showed an increase of 160% from 2008.

The takeover price of each entire business for BHI, HAL and SLB to date, **May 19, 2013** is $25, $45 and $106 billion at $$56.74, $48.43 and $79.4 per share, respectively. Moreover, the market price to date is $47.53, $45.25 and $75.74 per share for BHI, HAL and SLB, respectively.

The total debt for BHI, HAL and SLB was 18, 13 and 9%, respectively. On the other hand, the cash and cash equivalents were 7, 7 and 5%, respectively, for BHI, HAL and SLB. If you are buying the entire business, the amount you will pay will be for the equity plus the total debt. The result would be: 89% equity plus 11% debt for BHI, 94% equity plus 6% debt for HAL, and 96% equity plus 4% debt for SLB.

**3. Benjamin Graham's Margin of Safety**

The basic meaning of "Margin of Safety" is that investors should only purchase a security when it is available at a discount to its underlying intrinsic value - what the business would be worth if it were sold today. The key point for investors to remember is that they should only invest in a company when its stock is trading below what the firm would sell for in the open market. Those investors who ignore valuation concerns and overpay for their investments are operating with a zero margin of safety. Even if their underlying companies do well, these investors can still get burned, according to many passionate followers of Graham.

I will share with you the formula for the margin of safety and the intrinsic value:

**Margin of Safety = Enterprise Value - Intrinsic Value**

**Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)**

**Expected Annual Growth Rate = Long Term Growth Rate or G**

The Intrinsic Value factors the current earnings and the growth of the company. The formula is used to identify the difference between the company's value and its price.

Before considering buying any stock, I advise you to dig a little deeper and study the results of these calculations. I will guide you step by step. The table will show us the results of the calculations.

The results shows that BHI has an insufficient MOS because the percentage did not meet the requirement of Graham of at least 40%, while both HAL and SLB have a sufficient MOS, meaning their stocks were trading at 40% below the intrinsic values or the true values of their stocks.

In line with the calculation of the margin of safety is the growth rate of the companies. The MOS factors the intrinsic value and the intrinsic value factors the earnings per share (EPS) and the sustainable growth rate (SGR) plus the annual growth rate. The SGR factors the return on equity (ROE) and the payout ratio. Thus, the computation for the MOS goes a very long way. The table below will show us the results of the calculations for growth.

The SGR for BHI, HAL and SLB was 13, 21 and 25%, respectively. In addition, the return on equity was 11, 18 and 20% on average, while the earnings per share were $3.07, $2.19 and $3.75 on average, for BHI, HAL and SLB, respectively. In addition, SLB has the highest payout ratio and net margins.

The SGR shows how fast a company can grow using internally generated assets without issuing additional debt or equity. To calculate the SGR for a company, you need to know how profitable the company is as measured by its return on equity (ROE). You also need to know what percentage of a company's earnings per share is paid out in dividends, called the dividend-payout ratio. From there, multiply the company's ROE by its plow-back ratio, which is equal to 1 minus the dividend-payout ratio. SGR = ROE x (1 - dividend - payout ratio).

**4. Solvency Ratio**

The Solvency Ratio is used to gain insights into the long-term health of a business. Solvency is a quantitative measure of a company's ability to meet its long-term debt obligations. The solvency ratio measures the size of a company's after-tax income, excluding non-cash depreciation expenses, compared with the firm's total debt obligations, and it provides a measurement of how likely a company will be to continue meeting its debt obligations.

Liquidity ratios are similarly used to determine a company's ability to meet its short-term debt obligations. A company that is consistently having trouble meeting its short-term debt is at a higher risk of bankruptcy. Liquidity ratios are a good measure of whether a company will be able to comfortably continue as a going concern.

The table shows that all three companies have the capability of meeting their long-term obligations when the due dates arrive. The total debt against the total assets of the companies was less than 20% for BHI, HAL and SLB. Moreover, the liquidity ratios indicate that the three companies have the capability of meeting their short-term financial obligations as well. It indicates that the three oil and gas companies are financially healthy.

**5. Relative Valuation Methods**

The Relative Valuation Method for valuing a stock is to compare market values of the stock to the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock. The Price to Earnings/Earnings Per Share (P/E*EPS) will determine whether the stock is undervalued or overvalued by multiplying the P/E ratio by the company's relative EPS and then comparing it to the enterprise value per share.

The P/E*EPS valuation tells us that the stock prices of BHI, HAL and SLB were overvalued because the market prices were greater than the P/E*EPS ratios. Furthermore, the EBITDA/EV was 15, 13 and 10% for BHI, HAL and SLB, respectively. The EV/EBITDA tells us that it will take 7, 8 and 10 times the cash earnings of the company to recover the costs of purchasing the entire businesses of BHI, HAL and SLB, respectively. In other words, it will take 7, 8 and 10 years to recover the costs of buying the entire businesses of BHI, HAL and SLB, respectively.

**Final Verdict**

Overall, the stock prices of BHI, HAL and SLB were overvalued as the result of the relative valuation. In addition, buying the entire business of each will take a long period of waiting to recover the costs of buying. Moreover, the margin of safety of BHI was insufficient and has not passed the requirement of Graham of at least 40% below the intrinsic value. HAL and SLB have sufficient margins of safety, meaning their stocks are trading at 50% below the true value of the stock and can be good candidates for a Buy.

Therefore, I recommend a Hold on the stock of BHI; and a Buy on the stock of HAL and SLB.

**Bottom Line**

I believe the best bet is **Schlumberger****.**

**Disclosure: **I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.