The Best Oil Stock You Never Heard Of

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By Paul Tracy

NEW YORK ( StreetAuthority) -- There simply aren't many opportunities like this one. It's an energy investment, but it's a far cry from the oil majors such as ExxonMobil ( XOM) or Chevron ( CVX).

In fact, this is one of those investments I'd guess only one in 20 investors know about.

Let me explain . . .

Most energy investments you find on the New York Stock Exchange are actually pretty complex. They are companies that own land, wells, derricks and trucks. They have employees. They have to deal with spills, lawsuits and cleanups. That's a lot to handle and still pump out a profit.

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Take Chevron, for example. In a recent quarter, it generated $64 billion in revenue . . . but $52 billion of that went toward employee salaries, marketing campaigns, administrative overhead and other operating expenses.

And then Uncle Sam took $5.5 billion in corporate taxes. That still left a respectable $7.7 billion in pure profit. But Chevron pumped the vast majority of that right back into the business to find and develop new sources of oil.

Chevron is a complex oil giant, but the company I'm going to tell you about is the exact opposite. It couldn't be any simpler . . . or more lucrative.

This stock -- SandRidge Mississippian Trust ( SDT) -- simply takes in royalties and then pays them out to investors.

As a royalty trust, SDT owns a stake in dozens of wells run by its parent company, SandRidge Energy ( SD). SandRidge Energy takes care of the drilling, production, marketing and selling of the oil and gas produced.

The royalty trust -- SDT -- is passive in the relationship. It doesn't have to do a thing. In return for the initial investment when it went public, its investors get a cut of all the oil and natural gas sold from the wells between now and when the trust is scheduled to dissolve in December 2030.

To create SDT, SandRidge Energy packaged a 90% interest in 37 of its oil and natural gas wells in Oklahoma. In other words, for every $1 in oil or gas pumped by these, more than three dozen wells, owners of the royalty trust are now entitled to 90 cents in royalties.

But that's just the start . . .

You see, most trusts simply package up some of their reliable reserves and wells, sell them to the public as a trust and that's the end of the story. Those interests in the wells pay out steady dividends and not much changes.

But SDT is a different breed of trust. That's because in addition to the 37 wells it owned at its inception, the trust also gets a bonus. Between its inception in December 2010 and December 2015, parent company SandRidge must drill an additional 123 wells, of which SDT will own a 50% stake.

In other words, in the next several years each unit of this trust will have a stake in an increasing number of wells . . . meaning increased royalties and distributions.

Because the trust is so new, it has only made two dividend payments so far -- one of $1.07 per unit (for a longer-than-usual period of January through May 2011) and another for 82 cents per unit.

But the trust has outlined its projected distributions for the next four years. If you take the midpoint of these projections, then it adds up to payments of $2.73, or a 10% yield at recent share prices.

But here's the best part -- the trust has significantly topped its projected distributions so far. In the recent quarter when it paid 82 cents per unit, it had targeted a distribution of just 66 cents.

In other words, the trust topped its targeted distribution by 24%. This shows management is already underpromising and overdelivering. As a royalty interest holder in this trust, I like that.

Action to Take --> Because SDT is a royalty trust, the tax implications can be complicated. You will probably want to entrust your tax filing to a competent accountant. But don't fret too much about Uncle Sam. Although royalty trusts such as SDT can create some minor tax headaches, the trust's 10% yield -- and the potential for rising distributions in the future -- should prove to be well worth the hassle in the long run.

This is also why I have tabbed SandRidge Mississippian Trust as one of my " Top 10 Stocks for 2012." This select group of just 10 ideas are the ones we've marked to outpace the broader market over the coming year.

You can learn more about what we uncovered -- including some names and ticker symbols -- by reading our latest research.

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  • At the time of publication, Tracy and/or StreetAuthority, LLC held a position in SDT, although positions can change at any time. This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.