We closed this position on March 2, 2015. A copy of the associated Position Update report is here.

Check out this week’s Danger Zone interview with Chuck Jaffe of MarketWatch.com.

In the Danger Zone this week is Cabot Oil & Gas (COG).

This stock is also on my Most Dangerous Stocks list and gets my Very Dangerous rating. It makes that list because (1) the company reports positive and rising GAAP earnings while economic earnings are negative and declining and (2) the valuation is sky high.

COG’s GAAP earnings move in the opposite direction of their economic earnings because of balance sheet issues:
1. $857mm in net deferred tax liabilities
2. $17 million in off-balance sheet debt and
3. $313 million in accumulate asset write-downs. The $313 million in asset-write-downs is a indicator of management’s inability to create shareholder value. I call that managment failure given that managment’s primary responsibility to shareholders is to create value and be good stewards of capital, not destroy it. Here is more on write-downs as indicators of managment failure.

$313mm in accumulated write-downs means that for every dollar of capital in the business, management has destroyed about 10 cents. That is a serious rate of destruction that makes believing in future value creation difficult. Despite what the accounting results show, this company is not making money.

However, the stock market’s valuation of the stock completely overlooks this point. At ~$50/share, the valuation of COG stock implies the company will grow its NOPAT at nearly 20% compounded annually for twenty years. Those are some lofty expectations. Too high and too much risk for me especially when my model shows the company is destroying value.

Note that there are several energy stocks that I like and own including Exxon (XOM), Chevron (CVX) and Holly Frontier (HFC) – which are more into refining instead of exploration and production like COG.

I would also avoid Direxion Daily Natural Gas Related Bull 3x Shares (GASL) and First Trust ISE-Revere Natural Gas Index Fund (FCG) becuase of their 4% allocation to COG and their Very Dangerous and Dangerous ratings.

Disclosure: I own XOM, CVX and HFC. I receive no compensation to write about any specific stock or theme.


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