As an investor, you've likely found out the hard way that not all companies operating in the same sector offer similar risks or rewards. Sometimes your idea can be right, but you make the wrong stock selection, which can wreck your returns. That's why it's as important to pick the right stock not only to benefit from a long-term trend but also to fit within your risk tolerance.
One sector where there is a diversity of risk profiles is in the upstream oil and gas MLP space. While known for their high yields, it's important that you don't judge an upstream MLP by yield alone. That's easy to do because as you can see from the chart below, these yields can vary significantly:
|BreitBurn Energy Partners||10.50%|
|EV Energy Partners (NASDAQ:EVEP)||8.00%|
|LINN Energy (NASDAQ:LINE)||8.75%|
|Vanguard Natural Resources (NASDAQ:VNR)||8.75%|
|QR Energy (NYSE:QRE)||11.50%|
What's not obvious when looking at these yields is why there is any disparity at all. That's why it's important to drill down a little deeper into each company to see what sets them apart. Specifically, there are three important areas to look at in order to get a better idea of how safe and reliable those yields will be in the future.
Reserve mix An oil and gas MLP is only as good as the reserves it has in the ground. These reserves play a key role in how much future margin each company can capture as its reserves are produced. As you can see in the chart below, reserve mix does vary significantly from one company to another:
What's pretty evident is that as an investor you have three choices. You could choose a liquids-focused company like QR Energy LP (NYSE:QRE), balanced producers like Linn Energy LLC(NASDAQ:LINE) and BreitBurn Energy Partners L.P.(NASDAQ:BBEP), or the natural-gas-heavy names like Vanguard Natural Resources, LLC (NASDAQ:VNR) or EV Energy Partners, L.P. (NASDAQ:EVEP). If you are of the opinion that natural gas price will be heading higher in the future, then you would enjoy more potential upside by investing in those companies with larger natural gas reserves. On the other hand, if you like balance in your life, then investing in a company with a balanced reserve mix makes sense.