Diamondback Energy (FANG 3.75%) has become a big-time dividend stock in recent years. The oil company has grown its base dividend at an industry-leading 11% average quarterly compound annual rate since it launched the payout in 2018, including increasing it by 67% over the past year. In addition, it has started paying variable dividends from its oil-fueled cash flows. Those two payments have boosted the company's annualized dividend yield to 9.5%.

While Diamondback Energy's variable dividend will ebb and flow with oil prices, the oil stock recently made a deal to bolster its ability to produce free cash and pay dividends. That adds to its appeal for investors seeking to cash in on the current strong oil market.

Topping off the fuel tank

Diamondback Energy has agreed to purchase the leasehold interest and related assets of Firebird Energy. It's paying $775 million in cash and issuing 5.86 million shares to the seller (valued at about $811 million). That values Firebird Energy at three times its projected 2023 earnings before interest, taxes, depreciation, and amortization (EBITDA) and a 15% free cash flow yield at the current projection for oil prices. That's a good price, given how wildly undervalued oil stocks are these days at $90 oil

The transaction is highly strategic and accretive to its financial metrics. Diamondback CEO Travis Stice commented, "This bolt-on acquisition adds significant, high-quality inventory right in our backyard." He pointed out that it added over 350 adjacent locations in its current Midland Basin position, adding more than a decade of inventory at the company's current development pace.

Further, the transaction will enhance all its related 2023 and 2024 financial metrics, including free cash flow per share. Because of that, the company expects that the deal will enable it to boost its 2023 cash returns to shareholders by 3% on a per-share basis.

Following a successful blueprint

Diamondback Energy's latest deal follows the successful strategy of fellow oil producer Devon Energy (DVN 3.97%). That company has used a portion of its oil-fueled cash flows this year to acquire more cash-gushing oil properties. Devon acquired the leasehold interests of RimRock Oil and Gas in the Williston Basin for $865 million and purchased Eagle Ford producer Validus Energy for $1.8 billion. Devon paid only 2.2 times cash flow and a greater than 25% free cash flow yield for RimRock and two times cash flow and a more than 30% free cash flow yield for Validus.

Because of those low valuations, the deals significantly enhanced Devon's ability to grow its dividend. The RimRock transaction enabled Devon to boost its base dividend by 13%. Meanwhile, the company estimates that the Validus acquisition will allow it to increase its variable dividend by up to 10%.

While Diamondback Energy is paying a higher free cash flow multiple for Firebird than Devon did for its acquisitions, that's largely because it's buying assets in the highly prized Permian Basin. Even so, it found a highly accretive transaction that will enhance its cash flow and ability to return capital to shareholders.

Diamondback Energy has committed to return at least 75% of its free cash flow to shareholders through its base dividend, variable dividends, and share repurchases. That's up from its initial target of 50% earlier this year. The company returned 63% of its free cash to shareholders in the second quarter, an 11% increase from the first. It grew its base dividend by 7%, paid a sizable variable dividend, and repurchased $303 million of its shares. The company also doubled its share repurchase authorization to $4 billion. With a higher capital return target and the Firebird deal enhancing future free cash flow, Diamondback Energy could continue paying big dividends as long as oil prices hold up.

Increasing the attractiveness of its dividend

Diamondback Energy has become an intriguing dividend stock. The oil company pays a rapidly rising base dividend that it complements with a hefty variable dividend. While that secondary payout will ebb and flow with its oil-fueled cash flow, the company is enhancing its ability to pay dividends by acquiring the cash-gushing Firebird Energy. That's making Diamondback Energy an even more appealing option for dividend investors.