Hey dear friends; I wrote about oil and gas just recently but will share a few remarks here again today. I’ve received several good e-mails from readers of my book, Choose Stocks Wisely, in recent weeks. These e-mails have often queried about this company or that one, where the person was noting how discounted a stock was, often trading well below my adjusted floor price. In almost every situation, the company involved was in the oil and gas services sector.

Since buying any stocks involves forming judgments beyond the company numbers, perhaps it is worthwhile to ponder, in overall fashion, oil and gas stocks as an investment in light of how much lower oil has been trading over recent months.

Here’s the deal with many oil and gas companies right now, especially with those that service the sector (example of a service company would be a company that provides drilling “rig” services). Stock prices of many of these companies are very depressed now. Why do I say “depressed?” Well, you won’t have to look far to find companies in this space where the stock price per share is substantially below the company equity per share on the balance sheet (and a share of stock “is” a share of equity). Many are trading well below my own adjusted (scorecard method) floor price.

Oil and gas service companies are commodity-based companies in that they are dependent on commodity prices. As oil and gas prices go, so goes these companies, as a rule. Also, as a rule, these companies are capital intensive, meaning they have a large proportion of their total assets in the form of “fixed assets” (i.e. property, plant and equipment). These assets often are being supported by significant long term debt on the balance sheet. So, while the companies may have a lot of equity (excess of assets over liabilities) and even sufficient liquidity for the time being,as measured by my adjusted current ratio, they still have so much capital tied up in the fixed assets so as to pose a threat to the company’s future.

Those fixed assets are what generate the big dollars when demand for oil is high. However, companies can get in a financial bind pretty quickly when those fixed assets aren’t working for the company (as characteristic of present environment). Cash inflows slow and servicing debt can become problematic. Debt covenants can be violated too.

Remember, the stories I shared in my book about my hard experiences with a couple of dry bulk shipping companies that had a lot of equity amidst a dearth of demand for the ships. The collapse in demand persisted and collapsed many companies to date in the dry bulk shipping business.

A commodity-based company has a unique risk of being at the mercy of the associated commodity price. Oil and gas service company stock prices are deeply, deeply depressed for good reason, in my view. The value of the fixed assets on the balance sheet are being questioned by the investment community (relative to how they are pricing these sector stocks) because the oil and gas prices are so depressed and no one knows for how long. One thing is for sure; the companies able to maintain some degree of profit at a time like this and with balance sheets reflecting low debt and high liquidity stand the best chance of weathering the storm of depressed oil prices and coming out the other side real winners.

None of us knows when oil will bottom and then how quickly it will rebound. It’s purely speculation.

So, don’t be surprised by the depressed stock prices in the oil and gas (service) end of things presently. Even many major oil/gas producers have seen stock prices take it on the chin. These big producers (referring to names like Exxon Mobil, Shell, etc., as examples only), whether meeting my adjusted floor price or not, may end up presenting some good value in a setting like this since these large “producers” are probably more able to keep generating solid cash flow during this down time than are the “service” companies. Yet, big producers are being taken down in price too, just not as drastically.

Have a great next week.