By Peter Hodson

       For some reason, I have had a huge amount of success buying oil and gas stocks. I say "for some reason" because I am not a geologist, reservoir engineer or seismic expert.
       I was thinking about this the other day, and was wondering how I was able to pick stocks like Niko, which I first bought below $8 per share, or Pan-Ocean Energy, which doubled last year and is already up 20 per cent more in 2005. These are international names, but even my North American producers such as Cyries, up 26 per cent in 2005, and Thunder, also up 26 per cent, are doing well above average in terms of stock performance.
       Looking back, of course there was the usual number-crunching and ratio analysis I did in assessing which stocks in the oil and gas sector I should buy. But there were also many subjective and market factors involved. Let's take a look at what you should look for in a stock in the sector.
       First, examine the management team. If a group of people has a knack in finding hydrocarbon reserves, then stick with it. Don't invest in a management team that is just starting out.
       Buy companies such as Cyries (TSX CYS, $9.85, www.cyries.com) whose CEO, Don Archibald, has started and sold two successful companies already - Cypress and Cequel - and then simply went back to what he does best, building a new company. Cypress, by the way, was sold for close to $1 billion in 2001.
       Next, own shares in companies where the aforementioned management team owns a lot of stock. It sounds simple, but I prefer executives to have a lot riding on their company. I want them to be paying attention. I want them to hurt if their stock goes down.
       You can find how much shares management owns by going to public filings under www.-sedar.com. The annual information form will also tell you how much the executives are getting paid. Look for companies whose executives get paid very little but own lots of stock.
       Then, if you have experienced managers who know what they are doing, it is OK to pay a higher valuation for the shares. I can't recall the last time I made money by buying a "cheap" oil and gas stock. It is better to pay a premium price for a premium group of employees.
       Take Peyto Energy Trust (TSX PEY.UN, $53, 403-261-6081, www.peyto.com). CEO Don Gray isn't well liked in Calgary because he can find oil and gas better and cheaper than anyone else in town, and this causes a lot of jealousy. His stock has been expensive for years and years, even before he converted his company to an income trust.
       Well, that conversion happened when the shares were $11 each, and now they are $53 and pay a five per cent distribution, and they are still expensive. They will likely be expensive at $63, and $73, and so on. Pay a premium for a premium company.
       Similar to the above, there are two more related points: First, it is better to buy shares in companies whose shares prices are rising, not falling. A bit momentum-driven, it really does help to have other investors buying with you. Not a strategy for everyone, but a rising stock tells you two things - a company is doing well, and others have already noticed. Your job is to find out what the company is doing well, and whether it can keep it up.
       Second, buy companies whose last stock issues were below the current price. In other words, buy shares in companies that know how to keep their institutional shareholders happy. Happy shareholders, obviously, are more likely to support a company in the future, and are less likely to throw in the towel, causing you to lose money.
       Make sure you buy a company that has a nice mix of development projects and high-impact exploration plays.
The development projects provide steady cash flow and the exploration plays provide excitement and potentially big upside for investors. Some companies spend too much on exploration wells and never have the steady cash flow to pay for their next great idea.
       If you have found a company you like, then for heaven's sake give it time. I have seen many investors sell stock just because the shares haven't moved for a while. Note there is a difference between not moving and going down. A stock that continually goes down is a serious warning sign which many investors ignore.
Developing oil and gas reserves does take time, and many companies will hit the big time only after doing extensive seismic work and acquiring land positions.
Let's look at Rider Resources (TSX RRZ, $10, 403-266-0844, www.riders.com). Run by former Poco Petroleum management, Rider did basically nothing, stockwise, in its first year of existence. However, it has more than doubled since October as the work done earlier resulted in new discoveries. Many times I was tempted to sell my shares, but I knew this team would be unlikely to disappoint me over time.
       Finally, try to focus on companies whose market cap is more than $100 million, that have little analyst coverage and whose assets could be converted into an income trust.
       What you are looking for is a relatively liquid stock which could attract new coverage and new institutional investors. Too small of a company and nobody will care, and under-followed companies tend to have more upside when new analysts come on board. Finally, there is still some upside in finding oil and gas companies that can be converted into income trusts."
       Editor's Note: Excerpted from the Investor's Digest of Canada, 133 Richmond St., W., Toronto, ON M5H 3M8, 1 year, 24 issues, $137. Peter Hodson is a partner at Waterfall Investments and a sub-adviser to CI Mutual Funds.