Please ensure Javascript is enabled for purposes of website accessibility

These 3 Dividend Stocks Offer Big-Time Income Upside Potential

By Matthew DiLallo - Jun 23, 2021 at 10:04AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

These dividend payers are throwing some intriguing variability into the mix.

Dividend stocks tend to be relatively consistent. They typically pay the same fixed rate each quarter, with the best ones increasing the payout at least once each year. That enables their investors to collect a steadily rising income stream.  

However, a new type of dividend stock is emerging that's breaking the traditional mold: Variable dividend stocks. These companies offer the same steadily rising base payout. On top of that, they aim to supplement that fixed rate with variable dividend payments when they generate excess cash. Thus, they they offer big-time income upside potential. Here's a closer look at three companies with plans to pay variable dividends.

People counting money together.

Image source: Getty Images.

Leading the charge

Oil and gas producer Devon Energy (DVN 0.88%) unveiled the industry's first "fixed plus variable" dividend framework earlier this year. It targets paying a fixed quarterly dividend of around 10% of its annual cash flow that it intends to increase each year. That level allows Devon to maintain its payout during periods of lower oil prices. Meanwhile, the variable framework would see it pay out up to 50% of its excess free cash flow each quarter after funding its capital expenses and base dividend. 

Devon currently pays a fixed rate of $0.11 per share. That implies a 1.6% dividend yield at the current share price, slightly above the S&P 500's average. In addition, Devon paid its first variable dividend in March -- an incremental $0.19 per share -- and will pay the second one at the end of June. At $0.23 per share, the second payment was 13% above the initial one. Devon's latest variable dividend pushes its annualized yield up to 5% when combined with the base payout. Meanwhile, future variable dividends could be even higher given the company's dividend framework and leverage to higher oil prices. 

Same idea with a slightly different twist

Fellow oil and gas producer Pioneer Natural Resources (PXD 1.48%) set a similar dividend framework. It aims to pay a stable and growing base dividend that it compliments with a variable dividend. However, instead of making those payments based on its quarterly free cash flow, Pioneer will start paying variable dividends in 2022 based on its free cash flow in 2021.

Like Devon, Pioneer offers a solid fixed quarterly base rate. At $0.56 per share each quarter, the current yield is right around the S&P 500's average of 1.4%. In addition, Pioneer aims to pay out up to 75% of its annual free cash flow after covering capital expenses and its base dividend. However, it set the bar lower for the first year's payout, capping it at up to 50% of its free cash flow so that it can repay debt. Pioneer estimates that it can pay a variable dividend as long as oil averages $42 a barrel. With crude currently around $70 a barrel, investors appear poised to collect a gusher of dividends in 2022, with even greater upside potential in 2023 if oil prices stay elevated next year.  

Same concept, different sector

Timberland-focused real estate investment trust (REITWeyerhaeuser (WY -1.38%) also unveiled a variable dividend framework. Lumber prices, like oil and gas, can be highly volatile. That led Weyerhaeuser to reset its base dividend at $0.17 per share last year, low enough to sustain at historically low lumber prices. At a 2% yield, that's an attractive base rate.

Meanwhile, Weyerhaeuser plans to supplement this fixed rate -- that it also intends to grow over time -- with a variable dividend. Overall, the REIT expects to pay out between 75% to 80% of its annual funds available for distribution (FAD) -- a proxy for free cash flow -- each year as it supplements the base dividend with a variable dividend. It anticipates making this payment in the first quarter of each year based on the prior year's cash flow. Given how high lumber prices have been this year -- the company generated more FAD during the first quarter of 2021 than all of 2019 -- that payout could be significant. 

A strong base with enticing upside potential

Devon Energy, Pioneer Natural Resources, and Weyerhaeuser provide dividend investors with a sustainable fixed quarterly rate that they aim to grow over time. On top of that, each plan to pay additional dividends based on their actual cash flows. Those variable payments offer enticing upside potential to their already attractive base income streams, making them intriguing options for income-seeking investors.

 

Matthew DiLallo owns shares of Weyerhaeuser and has the following options: short July 2021 $35 calls on Weyerhaeuser. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Devon Energy Corporation Stock Quote
Devon Energy Corporation
DVN
$64.14 (0.88%) $0.56
Weyerhaeuser Co. Stock Quote
Weyerhaeuser Co.
WY
$36.58 (-1.38%) $0.51
Pioneer Natural Resources Company Stock Quote
Pioneer Natural Resources Company
PXD
$232.50 (1.48%) $3.38

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
402%
 
S&P 500 Returns
129%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/18/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.