Motley Fool: Seadrill’s risks look minimal against rewards

With the average bank account offering less than 1 percent in interest, it makes sense to seek income from dividend-paying stocks. If you can stomach some risk, shares of Seadrill (NYSE: SDRL) can reward you handsomely, with a dividend that recently yielded 11 percent!

Seadrill is a Bermuda-based offshore drilling giant, largely run by Norwegians. It leases rigs to operators and collects “day rate” payments for them. Seadrill has several advantages over its peers, such as an especially young fleet and a strong focus on deepwater rigs that will serve it well due to many new oil discoveries happening well below sea level.

Furthermore, supplies of deepwater rigs are tighter than other rigs, leading to higher day rates and fatter profit margins. And following the Deepwater Horizon oil spill in the Gulf of Mexico, the demand for safer rigs will favor Seadrill’s young fleet. The company has a strong contract backlog, too.

Seadrill isn’t perfect, though. It carries a lot of debt, and the demand for offshore drilling rigs is expected to slow down in the coming few years. Still, Seadrill seems able to manage its debt while maintaining its dividend payout, and depressed demand will eventually pick up. Seadrill’s risk-reward proposition is compelling, especially with its fat dividend and its single-digit price-to-earnings (P/E) ratio. (The Motley Fool owns shares of Seadrill and has recommended it.)

Ask the Fool

Q: What are audited financial statements? – M.W., Lake City, Fla.

A: Publicly traded companies (ones you can invest in on the stock market) are required to report on their earnings and financial condition each quarter. Once a year they issue comprehensive “10-K” reports, along with their annual reports. In the intervening quarters, they issue less substantial “10-Q” reports. 10-K reports include details on the company’s recent performance, risks and more, and their financial statements are audited by accounting firms. 10-Q reports, though, are not required to be audited.

Q: What is “goodwill”? – L.B., Philadelphia

A: A company’s balance sheet will often feature a goodwill sum if it has bought one or more other companies, paying more than their appraised net worth (their book value, roughly).

Imagine that Scruffy’s Chicken Shack (ticker: BUKBUK) acquires Buzzy’s Broccoli Beer Co. (ticker: BELCH). If Buzzy’s is a company others would love to acquire, Scruffy’s probably can’t just pay what the company is worth. Offering merely that might trigger counterbids. Thus, it pays a premium, which appears on an acquirer’s balance sheet as “goodwill.”

Imagine that Scruffy’s book value was $100 million before the acquisition and that Buzzy’s was calculated to be worth $20 million, but Scruffy’s offered $25 million in cash. Scruffy’s value won’t change. It will still be worth $100 million, but it wouldn’t have as an asset on its balance sheet that $25 million in cash that it paid. That sum would be replaced by the $20 million value of Buzzy’s as well as $5 million of “goodwill.”

Just as capital assets such as factory equipment depreciate over time, with their value decreased eventually to zero, goodwill is also incrementally reduced to zero.

My dumbest investment

In 1987 or thereabouts, I had $1,000 and a dream of investing. I asked a friend, “Hey, why don’t we put our money together and buy some stock in Apple?” I understood the company’s offerings, had used their computers in my previous job, and had been reading about the company reorganizing, refocusing and rebounding. The stock was near a 52-week low, but everything seemed to point to it getting its act together, and my gut said invest in it. But I let my friend talk me into investing in some silver mine instead, and of course we lost all our money. – Greg, Washington, D.C.

The Fool responds: Metals can be risky, as not all mines strike gold, or silver, or anything else. And the prices of precious metals can fluctuate a lot.

Gut feelings are not enough on which to base investment decisions, but listening to your gut can direct you toward investments in which you have the most confidence – especially after you research your investment candidates and understand them well. With your hard-earned dollars at stake, be wary of trusting anyone else’s gut.