3 Oil & Gas Stocks To Buy, 2 to Avoid

Michael is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Dividends are the key to any income investing strategy as they fuel the investor’s ability to compound returns and strengthen his or her position in a high yielding stock. Energy is one of the best places to find reliable dividend stocks due to the limited amount of fossil fuels on the Earth and the growing demand from emerging economies in the Third World. The following stocks may be worthy of consideration for your long term portfolio, but which stocks have the strongest staying power and growth potential of the group and which pose the greatest risk of losing steam?

Provident Energy (UNKNOWN: PVX.DL) pays very consistent dividends each quarter of around $0.05 per share, providing a very reasonable 5% yield on dividends each year. Its stock is extremely consistent and has shown steady growth over the past three years from $2 per share to over $11 now. My concern is that it has been losing considerably more money each year for the last two years it reported. That concern aside, it has reduced its liabilities from over $2 trillion in 2008 to $818 billion in 2010.

I think that Provident Energy is on the verge of breaking out of the red as it reduces its liabilities each year and continues to pay its shareholders each quarter. Despite this company being in the red for two of its last three reported years, I believe this is a buy because of the traction Provident Energy is getting, which will translate soon into profits and greater returns to the shareholder.

Eni (NYSE: E) is one of the most diversified oil companies in the world with strong diplomatic relationships across the globe that allow the company to do business in places such as Africa, the Middle East and Russia. Its diversity gives it some incredible staying power as it will always have an outlet to sell its resources to. Its dividends have fluctuated between $0.89 and $1.06 per share over the past year and it provided a yield close to 5%. The stability of this company is what makes it a buy, even though its yield could be a little better.

North European Oil Royalty (NYSE: NRT) is a very stable stock that has moved inside of a range of $27 to $35 per share with dividends that adjust from quarter to quarter. In 2011, it paid dividends at low at $0.55 per share and as high as $0.73 and produced an attractive yield of 8% for the year. While its stock has a history fast jumps and sudden deceleration, its price tends to speed up and put on the brakes within a consistent range, which makes me believe that North European Oil Royalty is more stable than its graph will suggest at a first glance. Reliability and a nice yield of 8% are what make me see this one as a buy this year— which will produce returns for a long time to come.

Exterran Partners (NASDAQ: EXLP) has raised its dividend payout for each of its last four quarters and provides a yield of more than 8% per year. Its incremental raises have been at half a cent per quarter, moving its payout from $0.4725 to $0.4875 per share at a payout ratio of over 8.06, which suggests to me that Exterran Partners is dipping into its reserves in order to payout its dividend and won’t be able to keep it up for too much longer. In order to continue paying out at a ratio of 8.06, this company will need to erode its reserves and liquidate its assets. It took a $23 million loss in 2010 and only produced $1.4 million in profit over the first three quarters of 2011. I think this well is drying up and Exterran Partners is poised to be a loser in 2012.

At a first glance, Torch Energy Royalty Trust (NASDAQOTH: TRRU) looks extremely enticing with a projected yield of over 28%, but I think that any high hopes in this stock will prove false. Its payout history is extremely erratic— its last four payouts were $0.03 per share in 2008, $0.35 and $0.10 in 2009 and $0.17 in 2011, skipping 2010 entirely. Not only is it difficult to predict when Torch Energy Royalty Trust is liable to payout, but it last paid out at a ratio of 5.66, which means the company paid almost six times out per share than it earned. I think this stock is a paper tiger and I would avoid it before it falls in on itself.

Provident Energy and North European Oil Royalty are the most reliable and low risk picks of this group and both stand to produce very healthy returns with strong growth potential. Exterran Partners and Torch Energy Royalty Trust both look like houses of cards to me and each stock’s success is artificial and will only last through the short term before each company is unable to keep paying out more than it is earning each year. Eni falls in the middle and while I think it is a safe buy, I would like to see it produce a more consistent dividend and higher yield before I rank it with Provident Energy and North European Oil Royalty.

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