Oil stocks have fallen out of favor in recent years. Investors have shied away from the sector due to climate change concerns and its volatility. That's causing them to miss out on some high-quality dividend stocks.

However, one investor who isn't missing out on the oil industry's dividends is Warren Buffett. His company, Berkshire Hathaway (BRK.A 1.48%) (BRK.B 1.06%), has amassed a massive stake in oil giant Chevron (CVX 2.60%). It pays an attractive dividend that currently yields 3.2%, double that of the S&P 500. Because the high-yielding Chevron is one of Buffett's largest holdings, it will provide Berkshire with over $900 million of annual dividend income.

Here's why you won't want to overlook one of Buffett's favorite dividend stocks.

Chevron's No. 1 priority

Chevron's integrated oil and gas operations generate a lot of cash flow. The company produced a record $15.3 billion of cash flow from operations in the third quarter, pushing its year-to-date total to $37.1 billion. After funding capital projects, Chevron produced $12.3 billion of free cash flow during the quarter. 

CFO Pierre Breber discussed the company's financial priorities for its free cash flow on the third-quarter conference call. He started with its no. 1 priority by stating:

We increased our dividend 6% earlier this year. We've been growing our dividend at a compounded annual growth rate of 6% for 15 years. And that is our first financial priority. 

This year's increase pushed Chevron's streak to 35 straight years of increasing its payout. That kept it in the elite class of Dividend Aristocrats.

Investing so it can grow the dividend

Because Chevron puts such a high priority on its dividend, it has built its business around its ability to maintain and grow its payout. That means focusing a significant portion of its post-dividend free cash flow on investments that increase its free cash flow, which is its second priority. 

Chevron is allocating capital to expand its traditional and new energy businesses. That strategy should enable it to meet today's energy requirements while gearing up to deliver the energy we'll need in the future. The company's traditional energy investment has it on track to grow its upstream oil and gas production at around a 3% compound annual rate. Meanwhile, its new energy investments have enabled it to become the second-largest biorenewable diesel producer in the country. These investments should help grow its cash flow over the long term, giving it the fuel to continue increasing its dividend. 

Maintaining a strong foundation

Chevron's next priority is maintaining a conservative financial profile so it can sustain its dividend and continue investing during the industry's inevitable downturns. Chevron has as close to a fortress-like balance sheet as you'll find in the oil industry. It paid down debt for the sixth straight quarter, driving its net debt ratio to 5%. That's well below its targeted net debt ratio of between 20% to 25%. That gives it the financial flexibility to withstand the industry's eventual downturns, putting its dividend on a very sustainable foundation. 

Allocating surplus cash to further enhance the dividend 

Another factor playing a role in Chevron's ability to grow its dividend is share repurchases. While buybacks are its fourth priority after paying a sustainable and growing dividend, growing its traditional and new energy businesses, and maintaining a strong balance sheet, they can have a meaningful impact.

Chevron bought back $3.75 billion of its stock during the third quarter, which was more than 1% of its outstanding shares. That has it on track to buy back shares near the top end of its $5 billion to $15 billion annual target range, which could see it retire about 4% of its outstanding shares. Chevron could thus increase its dividend per share by around 4% next year without boosting its total dividend outlay of about $2.7 billion per quarter. Add in the incremental cash flow from its growing business and the interest expense savings as it pays down debt, and Chevron has several dividend growth drivers.

A rock-solid dividend stock from the oil patch

Chevron has a lot to offer investors. It pays an attractive and sustainable dividend that it should be able to continue growing for years to come. It also provides upside exposure to the growth of traditional and new energy markets. These features have caught the eye of Warren Buffett, who made it one of his top stock holdings. So investors shouldn't overlook Chevron, especially if they're seeking a high-quality passive income stream.