Big oil is spitting out some big dividends these days. BP's (NYSE:BP) best-in-class dividend, for example, is currently yielding 5.7%. But just because it's the biggest doesn't necessarily mean it's the one investors should buy into. 

For my money, that award goes to Royal Dutch Shell (NYSE:RDS.A)(NYSE:RDS.B). Here's why.

A piggy bank with sunglasses sits on a beach chair on a beach with a body of water in the background.

Finding the right dividend stock can help you reach your financial goals. Shell's is the best in big oil. Image source: Getty Images.

Support structure

When evaluating a dividend -- particularly a high-yielding dividend like Shell's, currently at 5.6% -- it's important to consider whether the company in question is able to cover its dividend with cash from operations. A dividend that is paid with debt or with one-time items like asset sales isn't sustainable over the long term, and may indicate that a dividend cut may be on the horizon.

Indeed, the oil and gas industry has had a history of recent dividend cuts. Many independent oil and gas exploration and production companies have had to cut their dividends since the oil price slump in 2014. 

Looking at Shell's most recent quarters, though, it appears it has ample cash to cover its dividend.

Metric Q3 2017 Q2 2017 Q1 2017
Cash dividend payout $3.1 billion $3.0 billion $2.7 billion
Cash flow from operations $7.6 billion $11.3 billion $9.5 billion
Free cash flow $3.7 billion $12.2 billion $5.2 billion
Scrip dividend payout $0.9 billion $0.9 billion $1.2 billion

Data source: Royal Dutch Shell. Chart by author.

As you can see, Shell has been generating sufficient cash flow to cover its cash dividend.

No more scrip

Part of the way Shell -- along with other oil majors like BP -- has managed not to cut its dividend even as the oil price slump hurt its share price and ballooned its yield was by offering a scrip dividend program.

Shell gave investors the option to receive their dividends in shares instead of cash. This was just an option, not a requirement, so it wasn't an issue for shareholders, many of whom reinvest dividends anyway. The problem with a scrip dividend program is that the company issues more shares to cover the dividend, which dilutes existing shares. 

As you can see from the chart above, the scrip dividend program wasn't very large: Far more investors chose to receive their dividends in cash. But in the first quarter, the $1.2 billion scrip payout resulted in the issuing of 47.8 million Class A shares. That's just over 1% of the 4.1 billion shares that Shell has outstanding, so it doesn't dilute the stock's value much, but quarter in and quarter out, those payouts can add up.

Luckily, Shell has ended its scrip dividend program as of the third-quarter 2017 interim dividend payment on Dec. 20, so dilution from scrip dividends is no longer an issue. Clearly, the company is confident in its cash-generation abilities to shoulder the roughly $1 billion in additional cash payouts each quarter. That's another indication that the dividend is secure. 

A going concern

So, in Shell, we have an excellent yield, good dividend coverage, and in ending of the scrip program, a signal from management that it's confident in the company's ability to cover its dividend moving forward. But if the company is in trouble, or if its future looks bleak, that could be a bad sign for investors (as well as the future of the dividend).

Luckily, Shell seems to be firing on all cylinders. The company has been paying down the debt it took on when it acquired BG Group, as well as selling off underperforming assets to get its costs in line. It's been able to turn a profit and generate positive cash flow with oil prices around $50 per barrel. And now that Brent crude prices are above $60 per barrel, that should be icing on the cake.

Shell also apparently has an eye on the future. One of the reasons it bought BG Group was to increase its exposure to the natural gas and liquefied natural gas markets, which Shell's management believes will grow faster than the market for oil. It all adds up to a bright future for Shell.

The best in the biz

While other big oil companies -- BP -- may currently have higher yields, and some -- ExxonMobil and Chevron -- have a longer history of annual dividend increases, Shell's winning combination of a high yield, good coverage, and a positive corporate outlook make its dividend the best in big oil today.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.