Income investing isn't just for the soon-to-be retired. Research shows that, when done right, it can generate market-beating returns. In this week's episode of Industry Focus: Energy, analysts Sarah Priestley and Jason Hall look at some of the best dividend stocks in the energy sector, from Big Oil giant Royal Dutch Shell (NYSE:RDS-A) (NYSE:RDS-B) to solar power yieldco 8Point3 Energy Partners (NASDAQ:CAFD) and more in between. Listen in to find out what makes each of these companies a good dividend play, their different strengths and weaknesses, and how investing in a combination of them can help you mitigate some of those downside risks and still see a great dividend return.

A full transcript follows the video.

This video was recorded on Jan. 4, 2018.

Sarah Priestley: Hi! Just to let people know, this episode was pre-recorded before the new year. It was recorded on the 19th of December, 2017.

Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. Today, we're talking Energy and Industrials. It's Thursday, the 4th of January. I'm your host, Sarah Priestley. Today, we're going to be talking about five energy stocks that might help you earn some extra income this year.

If you're new to the show, maybe your New Year's resolution was to learn more about investing or learn about a segment of the market you're not familiar with, and you've come to the right place. Industry Focus goes live every weekday afternoon. We cover a different sector of the market each day -- financials on Monday, consumer goods Tuesday, healthcare Wednesday, energy and industrials Thursday and tech on Friday. So if you're looking to get your money working for you in 2018, we can help.

Today, we're going to be discussing energy stocks to add some nice income to your portfolio. Joining me on Skype is Motley Fool senior contributor and all-around nice guy Jason Hall. Jason, thank you for joining me today!

Jason Hall: Thank you for having me on! This is exciting!

Priestley: I don't know if you've had any thoughts yet -- do you know what some of your New Year's resolutions will be for 2018?

Hall: I have a few. Actually, I write a little bit of career content for The Motley Fool, and one of my biggest goals is to increase my earnings. I had a kid, Jan. 24, 2017, my first kid. It's been a busy year, so I haven't written as much as I normally do, and my income has gone down. So I wrote a piece, and I suggest people go find it. It talks about the difference between a resolution as a wish versus actually setting a goal you can measure and things you can actually achieve to hold yourself accountable. I'm holding myself accountable to make more money this year.

Priestley: That's a very good goal. And Jason threw out, we have some really great careers content that we just started last year, mid-2017, at the Fool. Some really fantastic contributors, including Jason. Check that out if you get a chance. Today, we've been generally talking about getting finances, and part of what can go into that is, if you have a lot of cash that you want to get working for you, is income investing. To start with a basics, Jason, what is income investing?

Hall: In general, the idea behind income investing is to identify companies that have strong, steady cash flows and strong market share, that have the ability to grow their cash flows over time, and there's a measure of predictability there for these companies to be able to pay a steady dividend, and most importantly have the ability to increase that dividend, ideally at a relatively high rate, certainly higher than inflation. Significantly higher than inflation is best, so that you can generate a steady stream of income that grows over time.

There's a lot of evidence that investing using an income-investing strategy and investing in dividend stocks, particularly dividend growth stocks, can actually generate market-beating returns. So it's really compelling, because a lot of times people think of dividend investing or income investing as this stodgy, boring, no-growth thing to do, but history has shown that you can beat the market doing this. So that's pretty cool.

Priestley: It is pretty cool. I completely agree with you. It's seen as so boring; it's seen as pretty much the reserve of retirement accounts. But to be honest, if you reinvest the returns you can get, the compound factor there really accelerates growth over a 10-year period.

Hall: Right, absolutely.

Priestley: I should note before we start the podcast properly talking about the five stocks that we're going to mention that this whole show has been based on an article that Jason wrote at the end of last year, "5 Energy Dividend Stocks You Can Buy Right Now." He wrote that on Dec. 11, 2017. Fantastic article, really good primer, and it links out to a lot of really relevant content. If anybody would like that, feel free to shoot me an email at industryfocus@fool.com.

But we will get going. We're going to be talking about oil and gas and energy in general. And it's been in the news a lot the last few years because of the volatility of the base commodity prices. But what makes these particular energy companies compelling for dividend stocks for you, Jason?

Hall: I think there's a couple of things. No. 1, one thing in common between the three companies -- Royal Dutch Shell, Phillips 66 (NYSE:PSX), and ONEOK Inc. -- is the fact that they all have a lot of involvement in natural gas, which I think is going to be a strong demand growth product when it comes to traditional oil and gas. That's the sector that I like the best. But they also have a lot of assets that generate that steady, predictable cash flow. Which, again, when you get to dividends, that's what you really need, as compared to an oil producer, where their business is drilling holes and pulling oil or natural gas out of the ground. They're heavily tied to commodity price movement. So when the prices go down, that can significantly impact their income and cash flows.

These three companies all have a certain measure of predictability for their cash flows and their ability to grow it, as we talked about in the primer to income investing.

Priestley: Jason, you and I are both bullish on the future of renewables, but I think it's worth noting for this discussion, we're talking about safe, or as safe as you can get, dividend stocks. Oil is going to be part of our world for the foreseeable future. So to put it into perspective, we do still have a long period of time where we will be transitioning to reduce our reliance on oil and gas. But globally, the demand for oil is going to be there for the next 50 years, at least.

The first company to mention is Royal Dutch Shell. Their ticker is [RDS]; they have A and B shares. Their yield is 5.7%. That's incredible. Shell is an integrated super-major engaging in the full range of oil and gas industry businesses. That basically means they kind of have a finger in all the pies. They're the second biggest public oil company traded on the U.S. markets, behind Exxon. What makes them a good dividend play?

Hall: If you go back through the heart of the oil downturn, which, it looks like we're starting to emerge -- prices are a little more stable; companies are able to make money where we are right now at this roughly $60 oil price -- Shell was engaged in the biggest merger, M&A activity, that happened during this downturn, when it acquired BG Group, which is another British-based oil and gas major.

The reality is, when this acquisition happened, there was a lot of concern because Shell took on a huge amount of debt to make this acquisition happen, but it was squarely aimed at increasing its natural gas business, where management sees a better future for growth. And oil is going to be hugely important, but when it comes to growth, natural gas seems like it's going to have better legs. Since that acquisition, the company has made a lot of changes to drive costs down, to sell off some of those non-core assets as it really refocuses its business after the acquisition.

When I invested in the company -- it's been six months or so when I decided to invest -- my timing worked out really well. The market was really concerned that all of that debt and the company's expenses were going to cause it to have to cut the dividend. And there was some risk of that. Over 2017, management has made efforts to reduce costs, really increased operating cash flows, got into a profitability point where the dividend is safe at this point. I don't think we can count on increases, but it's a relatively secure payout.

So I think if you want to get a really strong yield, even one that's not necessarily going to see dividend growth maybe in the next couple of years as the company focuses on paying debt down more and driving operating costs down more with its cash flows -- it's already a big enough yield that even if it stays flat for a few years, it's better than anything else. You're going to get a 3% or 4% yield that has growth potential. It's still not going to catch up. By the time Shell is ready to increase its dividend, it's still going to be paying a higher yield on your costs, probably, than a stock that might be yielding 3% or 4% today with small dividend growth.

Priestley: Yeah, absolutely. A story that we're seeing a lot with oil and gas companies is basically trying to reduce the cost per barrel to the company. So for Shell, they're doing a fantastic job. I think the last quarter, they actually produced pre-crash levels of cash flow, with oil prices at half of what they once were. So management is doing a really good job there.

The second company you mentioned in your article, Jason, was Phillips 66. Ticker PSX. Their yield is a little lower at 2.8%, but a bit more potential here.

Hall: Here's what I like about Phillips 66. Unlike Shell or ExxonMobil or any of the other super-majors, Phillips 66 is not a producer at all. It's still integrated. It's really well known for its refining operations, some of the largest refining operations in North America. It's a major petrochemical manufacturer, it's in a 50-50 joint venture with Chevron, it has significant oil and gas storage and pipelines that it operates, so it has a lot of diversity in different segments of the business. But it buys oil and natural gas. It doesn't produce a single bit of it. So that's actually been a benefit for the company over the past few years. When oil prices really started falling, that helped Phillips 66.

Its refineries are really advanced, so they can process a lot of different kinds of crude, so it was able to generate a little broader spread between its cost to purchase oil and refine it. So it was actually able to net higher profits on lower oil costs as oil prices were falling. So that's a competitive advantage that you're not going to see you from an integrated oil company that also produces oil, because if it's hurting its cash flows as oil prices fall down, the drop is probably going to exceed any benefit it gets from increased margins in its refining operations. 

When it comes to the growth side, Phillips 66 is consistently investing its cash flows back into growing its midstream business -- so its storage and pipeline business, its export facilities for things like LPG, investing a lot of money in expanding its petrochemical business. So think about growth. Kind of a little caveat here -- the petrochemical manufacturers are on track to invest something like $200 billion over a 15-year period in the U.S. Gulf Coast because of the massive amount of very cheap natural gas that's in North America. Phillips 66 is right in the middle of that. So since Phillips 66 was spun out of ConocoPhillips in 2012, Phillips 66 has increased its dividend every single year. I think it's up to 150%. It's only yielding 3%, but there's a lot of things to like about the business in terms of lower downside risk than, say, a Shell, which still has the downside exposure to oil prices and natural gas prices to fall again. It doesn't have that downside risk. So that helps offset a little bit lower yield.

But again, there's a consistent track record of annual dividend growth that the company should be able to continue to support. I think it's a good mix to actually own both of those two stocks, because you play a little of both sides of the coin there.

Priestley: It's a good idea. As you mentioned, since they split from ConocoPhillips in 2012, it's increased its dividend 7 times. It's grown now to 30% compound annual growth rate. That's really fantastic, and I think they just announced another $3 billion in share repurchases. They've done $9 billion since 2012, so that's going to put it up to $12 billion, which is going to reduce their outstanding share count quite significantly.

Hall: Since the IPO, since it was spun out, the share count has already been reduced by 18.5%. That's equity that you're gaining as an investor without buying another share. So that's pretty remarkable.

Priestley: The next company to mention is ONEOK, which I'm glad that you told me how to pronounce, because I would have got it wrong. The ticker is OKE. Their yield is 5.7%. They're specialized primarily in natural gas and natural gas liquids gathering systems and pipelines. The company used to fall victim to the volatility, similarly to the other companies we've spoken about, but they have moved nearly all of their agreements to fixed-price contracts, which have had a fantastic effect on the stock and the company.

Hall: Yeah. If you go back a year and a half ago, almost two years ago now, when oil prices were at the very bottom, something that was happening at the same time is natural gas liquids, things like isobutane, methane, propane, that are generally byproducts of natural gas production and also by products of oil production, the value of those commodities has fallen so far, because these things are coming up as oil and natural gas production just skyrocketed in North America. You're getting a significant amount of these by-products without any market to absorb them.

The problem was, ONEOK, at the time, all of its assets were held by a master limited partner, which it has since reacquired and consolidated into a single entity. I think at one point, maybe 25% or even 30% of its cash flows were tied to the commodity prices for those NGLs, the natural gas liquids, it was gathering. So it was a significant burden on the company's cash flows. But as you said, over the past two years, the company has renegotiated, and its contracts have come up, has made them fixed fee. Obviously, there's not as much upside if commodity prices go up, but if you're investing in a stock based on predictable income, management did the right thing. I think now, over 90% of cash flows are based on these fixed-fee deals. It's made for a much, much stronger dividend.

Here's the thing I really like a lot. It's yielding well over 5% today. But as part of the acquisition and integration of the master limited partnership, there's some tax benefits. The dividend is going to go up something like 20% a year for the next two years, maybe three years. So an investor today would capture 5.5%, 5.6% yield, and your dividend is going to go up substantially from there in the next few years. So that's something I really like about this company.

Priestley: Icing on the cake. And we've mentioned a lot about natural gas. If any of our listeners aren't familiar with it, we did a show back in the end of December about natural gas and how it's basically becoming more prevalent. The U.S. output is growing. I think 9% of what we produce right now is used domestically. But there's also a growing export market, especially in Europe, as European nations move away from Russian companies like Gazprom because of some price volatility that they've experienced there. So, big growth market, especially in liquid natural gas. Interesting company, absolutely. 

Outside of oil and gas, we have some stock recommendations in emerging energy sources. Wind and solar are getting cheaper. Storage, which has previously been, as Jason describes it, the missing piece of the puzzle, is starting to be addressed. We have a couple of stock recommendations based on the growth in that industry, the first being Pattern Energy Group (NASDAQ:PEGI), PEGI. Crazy yields. It's 7.9%, I think, right now?

Hall: Close to it. Just under 8% today. It's insane.

Priestley: It really is. This company owns 20 wind turbine farms. Correct me if I'm wrong on any of this, Jason. They have assets in the U.S., Canada, South America. They make money by selling the power that they generate on their wind farms to local utilities on long-term contracts. So they have a 14-year average life on these fixed-term contracts. Why do you like them for a different play?

Hall: A couple of things. Again, the reality, you mentioned this on the podcast, there's a shift that's starting to happen. As renewables are becoming more price competitive, I think investors should be willing to consider the reality that these things are going to continue to become a larger and larger share of the energy mix. They're going to be necessary around the world, whether you're talking about reaching environmental goals, whether you're talking about simply supporting the additional infrastructure that's going to be necessary as the global population grows.

It's going to be really important that we bring in solar where it's competitive with natural gas in most places in North America. It's cheaper than coal. It's cheaper than the nuclear. There's also scalability with wind that's really nice. Instead of building a power plant or even a peaker plant, you can add some solar or wind capacity to add incremental power to the grid at a lower per kilowatt-hour cost than adding really any other source of energy. 

The thing that I like about Pattern Energy particularly is its relationship to its parent company. Its parent company is a privately held developer that develops these projects, sells them off. And Pattern Energy, the public entity, has a great relationship there to participate in those projects. And the CEO of the development company and the public company, it's the same person. He owns almost 10% of Pattern Energy the public company. So you have a lot of skin in the game.

The other thing that I like that's happening is, the company has traditionally been solar but is now investing in power transmission. As these new assets are brought online, you have to connect them to the grid. It's getting ready to start making investments in storage. Again, because storage, like you said, and I've written, it's that missing piece of the puzzle, because if the wind isn't blowing, the sun isn't shining, it doesn't matter how cheap solar and wind are. They're not functional.

So as storage costs have come down, it's getting to the point where adding renewables that produce power more cheaply than fossil fuels and storage to have a place to keep that extra capacity and send it to the grid as necessary is making it completely competitive. And the costs are going to continue to fall. And since the costs are going to continue to fall, when you're talking about something like energy, the low-cost producer wins. So I think it's a great way to be invested in that future.

Priestley: Pattern Energy Group is a great way to be invested in some of that opportunity and earn something. Icing on the cake is to earn something along the while.

The next company to mention, we probably have the most to say about but the least time, is 8Point3 Energy Partners, ticker CAFD. Their yield is over 7%. They were originally established as a limited partnership by First Solar and SunPower as a way to monetize those companies' commercial and utility-scale solar projects. They would essentially sell projects to 8Point3, who would operate, sell the power, and then give them distributions back. There's recently been talk of selling stakes of those companies. What do you think this does to the dividend for this company?

Hall: It's kind of an interesting situation. The short version is, First Solar initially said it was interested in selling its stake in 8Point3. Initially, Sun Power was a little more cagey. But since then, the management said they were interested to sell off, too, and a couple things have happened. No. 1, when both of the partners want to sell, it creates a lot of uncertainty in the markets. So the stock price suffered a little bit, and that's why the yield has remained so high.

But the other side that's happened is, those two companies have also changed how they build these massive solar projects. SunPower is shifting away from that and doing a little bit of different work. First Solar is still going to do big projects but sees enough demand in the secondary market without having to rely on an entity that it controls to pass this along to.

Now, in terms of its cash flows, to support the current yield, the yield is as solid as it's going to get. I think their average contract life is almost 20 years. So there's very little reason to expect the dividend would go down. What really could happen -- it depends on when the time comes to find a buyer, who buys is, and what they choose to do with it. If it's kept as a publicly traded entity on its own, there's potential to grow that dividend. As new assets get dropped down, it has the ability to add assets to its base. If it gets rolled into another publicly or privately held company, I think there's some upside in the share price. It would certainly be sold for a premium to its current price. So there is some uncertainty. But for me, it's worth capturing that 7% yield along the way and riding out the story and seeing what happens.

I think the worst-case scenario is, you get your yield and a 10%-15% premium over the current stock price. The best-case scenario is it has the potential to be a Pattern Energy Group that's just more specialized just on the solar side, with steady grows along the way for years and years to come.

Priestley: Yeah. One of the potential buyout rumors is around NextEra, which is another company that we like a lot here, which is a utility heavily invested in renewables also. Jason, thank you so much for being on the first show of the year. I really appreciate it. As always, you are incredibly knowledgeable.

Hall: Hey, Sarah?

Priestley: Yeah? [laughs] 

Hall: Let may be the first to wish you a happy new year!

Priestley: [laughs] Thank you very much. That's it from us today. If you would like to get in touch, please feel free to email us at industryfocus@fool.com, or tweet us at Twitter, @MFIndustryFocus. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Austin Morgan kindly produced the show today. For Jason, I'm Sarah Priestley. Thanks for listening and Fool on!

Jason Hall owns shares of 8point3 Energy Partners, First Solar, ONEOK, Pattern Energy Group, Phillips 66, Royal Dutch Shell (B Shares), and SunPower. Sarah Priestley has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends ONEOK. The Motley Fool recommends First Solar. The Motley Fool has a disclosure policy.