Devon Energy (DVN 0.75%) is becoming an exceptional dividend growth stock. Since initiating its variable dividend program last year, the oil producer has steadily increased that payout. On top of that, it's raising the income floor by increasing its fixed quarterly dividend. These oil-fueled payouts could continue rising in the coming years, given Devon's low-cost oil business.

A cash flow gusher

Devon had a breakout year in 2021, fueled by higher oil prices and its strategic combination with WPX Energy that closed early last year. The combined company generated $4.9 billion of operating cash flow (three times what Devon produced in 2020) and $2.9 billion of free cash flow, the highest in its 50-year history. Cash flow was strongest in the fourth quarter at $1.6 billion, up 173% year over year, while free cash flow was up to $1.1 billion (four times higher than the year-ago period). 

Oil pumps at sunrise with money in the background.

Image source: Getty Images.

The combination of WPX Energy and Devon's drilling program helped boost its output from an average of 333,00 barrels of oil equivalent per day (BOE/D) during the fourth quarter of 2020 to 611,000 BOE/D at the end of 2021. Meanwhile, the oil company realized an average of $44.34 per BOE during the fourth quarter of 2021, compared to $24.77 per BOE in 2020's final period.

Returning the growing windfall to investors

Devon has taken a threefold approach to allocate its free cash flow. It launched an industry-first fixed-plus-variable dividend framework upon closing its WPX merger last year.

That strategy sees it pay out up to 50% of its excess cash in dividends each quarter after covering its capital expenses and fixed-rate quarterly dividend. The company allocates the other 50% to improve its balance sheet and repurchase its stock. In 2021, the company repurchased $589 million in stock (2% of its outstanding shares) and retained $1 billion in cash to strengthen its balance sheet. 

Overall, Devon paid out about $1.3 billion in dividends last year. That included a fixed quarterly base dividend throughout 2021 and a steadily rising variable dividend:

A chart showing Devon Energy's dividend payments over the last several quarters.

Data source: Devon Energy. Chart by the author.

Those payments added up to $1.97 per share in dividends for 2021. 

This year, the company sees the potential for even more dividends. Given where oil prices are these days, and the fact it can fund its business at $30 oil, Devon sees its free cash flow growing by more than 70% this year. Its strong fourth-quarter results will enable it to pay out a record $1 per share in the first quarter of 2022. That dividend payment features a higher fixed quarterly dividend of $0.16 per share (an increase of $0.05 per share, or 45%, from last year's base quarterly level) and another increase in the variable payout.

As things currently stand, Devon sees the potential for its dividends in 2022 to be twice what it paid out last year, suggesting that they could total $4 per share in 2022. That implies a more than 7% yield at the current stock price.

Even with that much higher dividend, Devon Energy will still generate billions of dollars in excess cash this year, given that crude oil is currently over $90 a barrel. That's leading the company to also boost its share repurchase program. It has increased its authorization by 60% to $1.6 billion, enough to retire 5% of its outstanding stock at the current share price. That steadily shrinking share count means Devon's dividends per share should continue rising as it makes variable payments over fewer shares.

A potential explosion of passive income ahead

Devon Energy's merger with WPX Energy is paying massive rewards. It increased its production while reducing costs, enabling Devon to produce more cash. With oil prices continuing to rise, the company is in the position to pay out even more in dividends this year. That makes it stand out as a great stock for investors seeking an income stream with lots of upside potential.