Many income investors focus on stocks with high dividend yields. However, a better approach is concentrating on dividend stocks that can grow their payouts at high rates, because these companies tend to produce greater total returns.
Two stocks with big-time dividend growth potential are oil producers Devon Energy (DVN +3.41%) and Pioneer Natural Resources (PXD +0.00%). Here's a look at why these oil stocks could fuel big-time dividend growth for investors in the coming years.
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The fuel for a potentially monster payout in 2021
Devon Energy currently yields around 2.3%, well above the S&P 500's roughly 1.5% average. That dividend is on a rock-solid foundation despite all the turbulence in the oil patch. That's because Devon can generate enough cash to cover its payout and the capital needed to keep its production flat at an average oil price of around $33 a barrel this year. On top of that, it has a fortress-like balance sheet with a low leverage ratio, more than $2 billion in cash, and minimal near-term debt maturities.
Given its strong financial profile, Devon plans to start paying a variable quarterly dividend of up to 50% of its excess cash. To put the size of those incremental payouts into perspective, at $40 oil, the company could produce more than $500 million of free cash flow.
If Devon paid out half those funds, it would more than double its dividend. Meanwhile, with crude oil prices currently above $50 a barrel, Devon is on track to produce an even bigger gusher of free cash flow this year of nearly $1.5 billion. Because of that, the company could easily more than double its dividend if oil prices hold up.
High-octane dividend growth potential
Pioneer Natural Resources pays an above-average dividend that currently yields 1.7%. It's also on a firm foundation despite all the oil market volatility. That's because Pioneer Natural Resources has an ultra-low-cost business model where it can produce enough cash at a mid-$30s oil price to fund its dividend and capital program. Meanwhile, it has a top-notch balance sheet backed by one of the lowest leverage ratios in the oil patch.
Because of its strong financial foundation, Pioneer also intends on adopting a variable dividend framework this year. While the company hasn't yet decided on how much it might pay, CEO Scott Sheffield said that, "the variable dividend, I anticipate to be much greater than our base dividend."
This payout will ebb and flow with oil prices. However, it could be more than double the current base payout level that the company also plans on growing at a modest annual pace.
Driving that view is the lack of alternatives for its excess cash since it plans to cap production growth at 5% per year (though it expects to keep output flat in 2021 despite higher oil prices) and no longer intends to buy back stock. It set those new ground rules because excessive growth and ill-timed buybacks have destroyed shareholder value over the years instead of creating it.
Well-supported base payouts with a gusher of growth ahead
Devon Energy and Pioneer Natural Resources are intriguing stocks for dividend investors. Both currently pay above-average dividends, supported by their low-cost operations and top-notch balance sheets. Meanwhile, they have the potential to pay out more than double their current level in the next few years, thanks to their plans to implement variable dividends. Because of that, they're great stocks for investors looking for explosive dividend growth potential.
