While the trailing P/E multiple is a useful value metric, it does not take a company’s future growth prospects into account. If an investor doesn’t mind incorporating a little more uncertainty into their analysis, they can also consider the PEG ratio, which is based on the P/E multiple and on analyst expectations for future earnings growth and is therefore a way to measure a stock’s upside potential. We track quarterly 13F filings from hundreds of hedge funds and other notable investors, including billionaire T. Boone Pickens (a former oilman who now manages BP Capital). These filings can be used to develop investing strategies (for example, the most popular small cap stocks among hedge funds outperform the S&P 500 by an average of 18 percentage points per year) and we also like to screen individual filings according to a number of criteria. Here are our thoughts on Pickens’s five largest holdings as of the end of March in stocks with five-year PEG ratios less than 1 (or see the full list of his stock picks).
Oil and gas refining and marketing company Tesoro Corporation (NYSE:TSO), which has more than doubled in the last year, was one of the largest new holdings in Pickens’s portfolio during Q1. Tesoro Corporation (NYSE:TSO) trades at 10 times trailing earnings, and with Wall Street analysts expecting net income to increase over the next several years the stock’s five-year PEG ratio comes in at 0.8. We would note that while earnings increased strongly in the first quarter of 2013 versus a year earlier, revenue was up by only 3% though of course the stock is priced cheaply as it is.
BP Capital was also buying Marathon Petroleum Corp (NYSE:MPC), which was spun out of Marathon Oil to manage the company’s refining and marketing assets and is currently up about 90% from shortly after becoming publicly traded. As with Tesoro- and, frankly, many other companies in the industry- Marathon Petroleum Corp (NYSE:MPC) is priced in value territory with both the trailing and forward earnings multiples being only 7. At that valuation the company would like quite attractive as long as it could prove capable of maintaining its current business.
Another downstream oil and gas company which Pickens liked was Phillips 66 (NYSE:PSX) with the filing disclosing a position of about 80,000 shares. Phillips 66 (NYSE:PSX) is how Warren Buffett has been playing a refining and marketing thesis, as Berkshire Hathaway had nearly $2 billion invested in the company according to its own 13F (find Buffett's favorite stocks). The company is valued at 8 times earnings, whether we compare its stock price to trailing results or to analyst consensus for 2014. While earnings doubled in its last quarterly report compared to Q1 2012, revenue was actually down 10%.
Pickens cut his stake in Anadarko Petroleum Corporation (NYSE:APC), but still owned 45,000 shares per the filing. The independent oil and gas company experienced a steep drop in net income in its most recent quarter compared to the same period in the previous year, but analysts apparently expect it to rebound: the forward P/E is 16, with the five-year PEG ratio being 0.9. It is the case that Anadarko Petroleum Corporation (NYSE:APC) delivered an increase in sales over the same time frame, but we still think that we would avoid the stock for now.
Rounding out our list of Pickens’s high upside potential picks is oil and gas exploration and production company Halcon Resources Corp (NYSE:HK). Halcon’s adjusted earnings numbers have been very low on a trailing basis, but analysts expect them to improve to 31 cents per share this year and 64 cents per share in 2014. That makes for a forward P/E of 9, and looking at further projections the result is a PEG ratio well below 1. However, the stock is down 41% in the last year and the most recent data show that 16% of the float is held short.
Halcon Resources Corp (NYSE:HK) therefore seems like a risky pick at least at this time, and we might want to hold off until we see how much progress the company is making towards hitting analyst targets. The downstream oil and gas companies are certainly cheap in earnings terms, and we’d be quite interested in learning more about them in search of good value prospects with at least some growth potential as well.
Disclosure: I own no shares of any stocks mentioned in this article.