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As every savvy investor knows, multiples are one of the best yardsticks when it comes to finding undervalued oil and gas stocks to buy.
More often than not, that involves a hard look at the multiple of a company's earnings to determine whether or not a stock is fairly valued.
In the case of energy stocks, however, there is a more important multiple you need to understand.
This yardstick applies most frequently to oil and natural gas stocks, although it has variants that can be applied to power producers and even coal and uranium miners.
This new tool looks at the relationship between a company's booked reserves and its trading price. It takes into consideration the extractable reserves a company has in the ground and opens up a window into how that stock should trade.
I've used this measure time and again to bring home market-beating trades. Once you understand how to use this yardstick, you can too.
Here's how it works...
How to Pick Potential Oil and Gas Stocks to Buy
Of course, using a measure like this is just one factor in determining a target price for a stock.
Aggregate supply and demand considerations, the broader corporate debt and working capital ratios, access to midstream and downstream transport and processing assets and at what cost, along with the market price itself, are certainly other important considerations.
Still, unlike companies in non-energy sectors, there is a rather direct correlation here between what is available as raw materials and how that translates into profit. Reserve multiples address the estimated value of oil and gas a company has accessible, but not yet extracted.
Actually, I prefer to consider this factor as extractable reserves, those assets in the ground that are both technically and financially extractable. That is, what an oil and gas company can extract immediately at a cost that is justified by the current market conditions.
Now, reserve figures are among the most manipulated statistics in the business. But looking at extractable reserves in a way that considers both the effects of technology and economics accomplishes two objectives...
About the Author
Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.