ETF Teardown: The Best Gas Stocks

Noted for their simplicity and other advantages over mutual funds, exchange-traded funds have become a popular investing tool. ETFs hold a collection of stocks that share certain elements in common, so if investors want to capitalize on the increasing energy consumption around the world, for example, they can turn to Energy Select Sector SPDR (AMEX: XLE), which invests in a mix of oil, gas, and energy stocks.

But since this ETF invests in a number of stocks, it gives investors a broad diversity that also limits your upside. For an investor who was, say, really hip to natural gas exploration but cold on oil refining stocks, this ETF wouldn't fit the bill.

Fear not, Fool -- in this edition of "ETF Teardown," we'll use some nifty tools to drill into the best of what the energy sector has to offer. To help, we'll use Motley Fool CAPS, our tool for screening and ranking stocks and stock pickers.

The power of tags
To help investors quickly locate great stocks, any of the 4,700 rated stocks that are profiled in CAPS can be "tagged" with a descriptor that groups the company with others that share a certain quality.

Since energy is such a large sector, there are a number of related tags in CAPS to choose from, including "Gas," "Oil & Gas Equipment & Services," and "Alternative Energy." Selecting the "Gas" tag in CAPS presents a list of 88 investments that trade on American exchanges. This particular collection of investments has risen 20.4% in the past year, essentially matching the gain in the S&P over the same period of time.

To get a sense of which companies the CAPS community thinks are the best opportunities in gas today -- and which they recommend staying away from -- we can sort this list by their CAPS star rank, denoted by one to five stars, with five being the best. Each of the individual companies can then be viewed for exactly who -- from Wall Street to Main Street -- is bullish or bearish on the company and why.

Getting down to the nitty-gritty
Here's a sampling of some of the favored -- and not-so-favored -- gas stocks our screen pulled up today.

Company


CAPS Rank

Chesapeake Energy (NYSE: CHK)


*****

XTO Energy (NYSE: XTO)


*****

ConocoPhillips (NYSE: COP)


*****

Goodrich Petroleum (NYSE: GDP)


**

Gasco Energy (NYSE: GSX)


*

It's not too hard to find a gas company that the CAPS community is pumped on -- 29 of the 88 stocks included in this group carry a five-star rating. With growing demand for energy in the U.S., it's hard to vote against this long-term trend. Chiming in on this opportunity, investors are particularly vocal about Motley Fool Inside Value pick Chesapeake Energy, as well as oil and gas explorer XTO Energy and integrated energy concern ConocoPhillips.

In the case of XTO energy, the company has a strong track record in developing gas properties efficiently, producing more natural gas for the invested dollar. CAPS investors cite management's ability to make wise acquisitions at a good price, and then use advanced technology and techniques to extract more value out of the reserves than competitors. With co-founder Bob Simpson still acting as CEO and deep experience in the executive team, it's easy to see why 158 of the 160 CAPS All-Stars giving an opinion on the independent production and exploration company expect it to beat the market going forward.

Much larger and diversified energy company ConocoPhillips ignites investor enthusiasm for potential market-beating returns as well. The company's international presence, size, and diversity give many investors confidence that ConocoPhillips can weather cycles in the energy market better than more focused, regional concerns. With the stock trading at a low P/E of 8.3 and offering a 2.1% dividend yield, investors wonder if the market is sniffing fumes by offering the company at a discount to peers such as ExxonMobil (NYSE: XOM). Strong growth prospects and a sizeable $4 billion share-buyback plan also contribute to bullish votes from more than 96% of CAPS investors.

The larger trends of rising energy costs and increased demand around the world aren't enough to float the boat of all gas stocks, though. CAPS investors are especially pessimistic about Gasco Energy's chances of beating the S&P going forward. Shares of the company have dropped more than 20% over the last two years, as the company has yet to turn its gas reserves into bottom-line profits. Even improving operational cash flow hasn't changed the mind of investors yet -- half of CAPS All-Stars still give the company the thumbs down.

You can lead a horse to water ...
Plucking individual stocks from a diverse sector such as gas or oil is, of course, a high-risk endeavor. Investors should always perform their own due diligence on companies rather than take a recommendation. After all, even the best stock pickers can be horribly wrong on a stock.