Picks, Pans & Shovels Part 2: A New Listing To Buy & Hold

Last week, with reference to solar power, I outlined the basic reasons to invest in those that supply an industry rather than specific individual companies. The logic is obvious. Investing in suppliers allows you to participate in the upside of a booming industry without company specific execution risks. If you sell the tools needed to prospect or explore, then who, if anybody, hits pay dirt is irrelevant.

Of course, the theory can be applied to traditional as well as alternative or emerging industries. Traditionally energy is not derived from the sun, but drilled for. Superior Drilling Products Inc. (SDPI) is in the business of supplying those that drill.

That isn’t the entire story, however. They started as a company that repaired Polycrystalline Diamond Compact (PDC) drill bits, the business end of oil and other mining drills. They have moved into the manufacture and supply of drilling equipment and, on Wednesday, were granted a patent for their “Drill-n-Ream” tool. Details of what that is can be found here, but from an investor’s perspective what you need to know is that the company is likely to see significant growth on the back of it.

SDPI is not a stock for the faint of heart. It only started trading last week after the IPO was priced below the expected range, at $4 compared to a $5-7 forecast. The lack of institutional demand that a low initial price indicates is a red flag to many, and the fact that the stock has jumped around 60% since then to trade at around $6.40 hardly makes it look like value.

From a fundamental perspective, however, it could well be one of the best value stocks in the broader energy sector. Even using analysts’ estimates from before the patent was granted and not taking into account the sales team expansion the company says it will undertake as a result, the current price translates to a forward P/E of around 20. That is above average, but not unreasonable. Once the growth potential is factored in, however, it will look extremely cheap.

Nor is investing in SDPI about faith that one day some wonder product will result in a profit. They already make money and have a forecast EPS of $0.29 for the next year. Given a choice, I would always rather own stock in a company that has shown the ability to make a profit than one with potential to do so. The dangers of that can be seen by a quick glance at the last 6 months performance of Twitter (TWTR).

From an energy portfolio perspective, SDPI has one other advantage. It is a direct play on the expansion of the US and international energy market that is not dependent on, or particularly sensitive to, the price of oil. A drop would slow the pace of exploration and therefore the potential rate of growth for SDPI somewhat, but exploration will continue.

SDPI represents an opportunity to get in early on a company with potential to become a major player in the oil and gas industry supply business. They have already shown that they can do the two most important things for any business; grow and make a profit. As coverage of the stock is initiated at major Wall Street firms over the next few months you could well see a short term boost in the price, but the real value here is in the prospect of Superior Drilling continuing to grow and make money over the long term as they supply the drilling industry with their version of “picks, pans and shovels.”