If you're looking to invest in oil and gas stocks, Devon Energy (DVN 3.13%) is a worthy candidate. The oil and gas producer has a trailing dividend yield of 4.8% and provides an attractive way for investors to increase their passive income if oil prices remain high. Here's what you need to know about Devon Energy before you buy it today.
Devon's dividend rises alongside oil prices
Devon Energy explores and produces crude oil and natural gas primarily onshore in the United States, making it an upstream oil company. As an upstream operator, Devon makes money selling its oil and gas at market-determined prices, and its profits are tied closely to the price of oil.
This can be a strong tailwind for the company when oil prices rise, like in 2022, when the U.S. placed sanctions on Russian oil following its invasion of Ukraine. As a result, West Texas Intermediate (WTI) crude oil prices shot up to over $120 per barrel and stayed elevated for much of the year.
Devon's earnings jumped to $6 billion during the year, more than doubling the previous year's earnings of $2.8 billion. Its free cash flow was also $6 billion, the highest in company history, enabling the company to double its dividend payout to $5.17 per share.
As an income investor, you might be drawn to Devon for its dividend payment. But first, you'll want to consider how it's structured.
Devon uses a fixed-plus-variable dividend payout strategy. It aims to pay 10% of its operating cash flow through a fixed dividend plus a variable dividend of up to 50% of its excess free cash flow. As a result, you can rake in the cash when oil prices rise. But it also leaves you vulnerable to dividend cuts, which is exactly what happened in 2023.
DVN Dividend Per Share (Annual) data by YCharts.
Oil prices have stabilized, with WTI Light Crude Oil trading around $70 to $80 per barrel for much of the past year. As a result, Devon's earnings have fallen alongside its dividend. Last year, its earnings fell by 38% to $3.7 billion, while free cash flow came in at around $2.7 billion. As a result, its dividend was cut multiple times, and the dividend payout fell to $2.87 per share.
Geopolitical tensions and underinvestment could keep oil prices elevated
If you're bullish on oil prices long term, owning Devon stock could be an excellent way to express your investment thesis.
Oil prices could remain elevated because of tight supply and ongoing geopolitical tensions. OPEC+ has made a series of cuts since 2022 to support markets, and members, led by Saudi Arabia and Russia, are committed to further reducing oil production and inventory levels.
Image source: Getty Images.
In addition, the U.S. economy has remained resilient, and energy demand remains robust. Many U.S. producers are cautious about ramping up production because they fear overproducing after so many suffered huge losses in the 2010s from debt-fueled overexpansion. On top of that, long-term underinvestment could be another tailwind for elevated prices.
According to a report by Morgan Stanley, capital spent on oil exploration is half of what it was in 2014, while demand has increased by 5% over the same time. "The current levels of investment fall significantly short of what's required to meet potential oil demand growth, leading to a supply shortfall," according to the report, and analysts anticipate "an oil price floor at around the marginal cost of $80 a barrel."
Is Devon Energy right for you?
Devon Energy is a cyclical stock, and its performance depends on oil and gas prices. If you're bullish on oil prices due to years of underinvestment and ongoing geopolitical factors, Devon Energy -- and its fixed-plus-variable dividend payout -- is an excellent way to play this upside potential.
On the other hand, if you want to invest in oil and gas but prefer a more stable, reliable dividend, consider integrated oil and gas companies like ExxonMobil or Chevron. These companies have raised their dividends for 41 and 37 years, respectively, and have a more stable business model that could do well even if oil prices fall.
