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Hallmarks of Success for Energy Companies
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Oil companies have typically been successful at adding value for their shareholders. Here are some characteristics we look for in the industry.

Strong Financial Track Record

Over a complete cycle (e.g., five years), has a company been able to profit? For an integrated oil company such as ExxonMobil or BP, we want to see profits even during years when oil prices sag. The year 1998, when crude neared $10 a barrel, is a good barometer here. For a company that does only exploration and production and has no refining, dipping into the red during lean years is not disastrous as long as it can generate oversized profits during the boom years, such as 2OOO. The higher the profitability and the longer the track record, the better.

Clean Balance Sheet

Because they operate in a cyclical sector, it's important that companies have the financial wherewithal to make it through the lean times that periodically hit. This is especially true for companies focused on exploration and production. Growing while staying away from debt can be done, as ExxonMobil and Shell's essentially debt-free balance sheets prove. A debt-to-equity ratio below 1.0 is preferable.

Reserve Replacement Ratio Greater than 1.0

The reserve replacement ratio is the amount of new oil a company has found

in a period divided by the amount of oil it has produced during that same period. If a company is pumping more than it's finding, reserves (which represent future production) will shrink. It may then need to spend more on exploration or acquisitions of existing fields to maintain revenues.

Shareholder-Friendly Uses of Cash Flow

The energy sector is mature, so steady firms such as the major integrated companies generate far more cash flow than can economically be reinvested in the business. Most good oil companies should pay a stout dividend and/or be repurchasing their shares while still spending on growth opportunities.

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