Beware: Dividend Cuts Loom for These 3 Stocks

Beware: Dividend Cuts Loom for These 3 Stocks

Devon Energy (NYSE:DVN) has a dividend yield of almost 5%. Pioneering natural resources (NYSE:PXD) gives a yield of around 4.3%. And Diamondback Energy (NASDAQ:FANG) has a yield of around 4.2%.

These are rather attractive returns given that the S&P 500 Index today yields only about 1.3%, and the average energy stock yields 3.2%, using the Vanguard Energy Index ETF as agent.

There’s just one problem: you can expect Devon, Pioneer, and Diamondback to cut their dividends.

Energy is a volatile sector

These three producers are all energy producers, operating in what is known as the upstream segment of the broader market. energy sector. These are very volatile businesses because the oil and natural gas they produce determine their bottom line and results.

Oil and natural gas are subject to rapid and dramatic price fluctuations. There are all sorts of reasons for this, including the impact of supply and demand, changes in global economic growth and even geopolitical conflicts.

But no matter why oil and natural gas prices fluctuate; as an investor, you simply need to know that volatility is the norm. And this has exactly the impact you would expect on Devon, Pioneer and Diamondback since the only thing they do is produce oil and natural gas.

That said, each of these dividend payers has chosen to adopt a dividend policy that rewards investors when energy prices rise. They each have a “basic plus variable” dividend policy linked to their financial performance. The basic dividend ensures a certain stability in its payment. This is actually a very good way to ensure that investors benefit directly from high oil and natural gas prices, since rising energy prices lead to higher dividends.

But there is a trade-off. When energy prices fall, the variable portion of the dividend is reduced. So, by design, Devon, Pioneer, and Diamondback will fail if you buy any of them thinking that the yield you see is a reliable indicator of the future income you will receive from owning them. The dividend yield in each of the company profile images here shows the base dividend yield. This should give you a better idea of ​​what these payouts look like without the variable dividend.

What’s going up…

The chart below – featuring the price of West Texas Intermediate (WTI) crude, a key industry benchmark, and the dividend histories of Devon, Pioneer and Diamondback – shows very clearly what variable dividend policies mean in life real. As WTI rose, so did the dividend payments made by this trio of energy producers. But when oil prices started to fall, well, dividends followed suit.

Beware: Dividend Cuts Loom for These 3 Stocks

DVN dividend per share chart (quarterly)

This is exactly what you would expect given their dividend policy. And to be fair, dividends have risen again, along with energy prices. This will likely get some dividend investors excited about the future earnings prospects here.

But don’t fall into this trap if you’re looking for reliable dividend payers. By design, Devon, Pioneer and Diamondback are inherently unreliable.

This doesn’t mean they are bad companies. This is something you need to decide on a company-by-company basis by looking at their unique business fundamentals. But the volatile nature of energy prices means dividend cuts are inevitable as long as variable dividend policies are in place.

Don’t fall for these returns

If you’re looking at the energy sector to try to find a high dividend stock, you’ll likely see Devon, Pioneer, and Diamondback pop up on your screens. Their yields are currently high compared to the energy sector as a whole.

But it’s something of a mirage when you consider the way they designed their businesses. A large return that does not last will not be a profitable investment for most dividend investors trying to live off the income from their portfolio. Devon, Pioneer and Diamondback are aimed at a different type of investor.

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Ruben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends Pioneer Natural Resources. The Motley Fool has a disclosure policy.

Don’t fall for these 3 dividend stocks: cuts are coming was originally published by The Motley Fool

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