The 3 Best Stocks for Investing in Oil and Gas Equipment

By Markets Fool.com

It may not seem like it, but investing in energy companies today can still be a good idea. Sure, there are plenty of stories about how cheap oil is causing everyone in the industry to fall on hard times, but based on the likely demand for oil and gas over the next several decades, it's hard to see how making smart investments in this space would be a drag on someone's portfolio over the long run.

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With so many energy companies to choose from, it's not always easy separating the wheat from the chaff. So let's look at a couple of the characteristics you need to look for when investing in an oil and gas equipment company and find a few examples of companies that fit the bill.

The kings of their realms
Those who sell equipment to the oil and gas industry work in a vicious space, as companies are always trying to outbid each other to ensure that their equipment supplies the next big wave of oil and gas exploration and production. Some of these companies do so through continuously developing new technology, others find ways to commoditize that technology and try to fight as low-cost suppliers, and others develop a particular niche that few can -- or want -- to engage in.

The successful companies in this space are the ones that can carve out a dominant market share in their realm of focus. They don't have to own the entire market for oil and gas equipment and services, but by gaining a dominant position in a particular piece of equipment, they can help protect their pricing power and customer base. What this means for the investor is that the companies can better handle commodity cycle downturns, generate free cash flow, and produce superior returns over the long term.

Let's look at three companies -- National Oilwell Varco , FMC Technologies , and Oceaneering International -- that have been able to secure that dominant market share and see how it's translated into strong share performance over the long term.

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^SPXTR data by YCharts

Company Management Rate of Reutrn* Return on Capital
National Oilwell Varco 42.4% 14.2%
Oceaneering International 32.9% 23.1%
FMC Technologies 43.1% 27.5%
Industry Median Value 24.2% 12.7%

*Management rate of return, defined as earnings before interest and taxes divided by the sum of a company's net property plant and equipment and its working capital, is a measure of how effective a company is at using the money it has tied up. Source: S&P Capital IQ.

As you would expect, these companies' market-beating performance over the past dozen years or so has a lot to do with how they have each carved out a dominant market share in their respective part of the oil and gas equipment market.

  • Thanks to management's move to standardize most of the equipment found on a drill rig, and through a slew of acquisitions, National Oilwell Varco now is the premier supplier of just about anything a company needs to drill. Its biggest success has been in the offshore rig market, where it produces more than 80% of offshore drilling packages -- all the equipment seeded specifically to drill. Not only does this dominance ensure that customers will go back to NOV for their next rig purchase, but it also provides a massive customer base to which the company can sell replacement parts, such as spent drill bits.
  • FMC Technologies is the closest thing to National Oilwell Varco when it comes to anything on the ocean floor. Most of us are familiar with the image of an offshore rig, but what most of us don't see is the equipment working below the surface, such as blowout preventers and artificial lift equipment. This is FMC's world, and its market share of greater than 40 -- based on total orders -- in subsea equipment is more than double its second largest competitor. Subsea equipment isn't in huge demand right now, with many of the big-spending producers cutting back capital budgets, but over the long term approximately 60% of new oil and gas production projected to come online between now and 2020 will come from offshore sources, and that means there there's plenty of demand down the road.
  • Oceaneering International is kind of in the same boat as FMC Technologies when it comes to demand for its remotely operated undersea vehicles used to install those blowout preventers and any other subsea equipment. With exploration budgets drying up, the demand isn't as robust as it has been recently. Still, the company owns more than 60% of the remotely operated vehicle market, which gives it plenty of control of the market in terms of pricing. With the company generating more than enough operational cash flow to cover its expenditures as well as its dividend, there are very few fears that this ship will sink any time soon.

What a Fool believes
Considering how much the share prices of these companies have plummeted in the past six months or so, I'll admit that they don't look like the most appealing stocks today. However, when you consider that these companies all provide an essential function that will be needed to produce oil in the future -- a trend that doesn't look to go out of style any time soon -- then it doesn't seem that harebrained to add these companies to your watchlist.

The article The 3 Best Stocks for Investing in Oil and Gas Equipment originally appeared on Fool.com.

Tyler Crowe owns shares of National Oilwell Varco. The Motley Fool recommends FMC Technologies, National Oilwell Varco, and Oceaneering International. The Motley Fool owns shares of National Oilwell Varco. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.