Oil prices are having another volatile year. West Texas Intermediate (WTI), the primary U.S. oil price benchmark, has done a complete roundtrip. It started in the mid-$70s and rocketed into the triple digits following Russia's invasion of Ukraine. Crude has since given back virtually all that ground on concerns the global economy is barreling toward a recession.
Even with all that volatility, shares of Diamondback Energy (FANG 0.92%) are up more than 30% on the year. However, the stock is still pretty cheap, given the free cash flow it can produce at the current oil-pricing level. On top of that, shares are down 15% from their recent peak, making the stock even cheaper. Adding to Diamondback's value proposition is that it pays an attractive and growing dividend, repurchases its cheap stock, and makes value-enhancing investments. These factors make it top my list as the best oil stock to buy this December.
An attractive valuation
Diamondback Energy has been feasting on higher oil prices this year. The company expects to produce more than $4.3 billion of free cash flow in 2022, well above the $2.4 billion it generated last year. That assumes crude averages $80 a barrel in the fourth quarter, which is right around its current level. With Diamondback Energy's market cap recently around $25 billion, it trades at a 17% free-cash-flow yield. That's one of the highest levels of its peer group:
Data source: Marathon Oil.
While Diamondback Energy might not be the cheapest oil stock in its peer group, it trades at a higher free-cash-flow yield -- and thus a lower valuation -- than the peer group average. It's also significantly cheaper than the broader market average, given the S&P 500's roughly 5% free-cash-flow yield.
That cheap valuation is leading Diamondback Energy to buy back more shares. The company spent $472 million to repurchase shares during the third quarter, 56% more than it spent in Q3. It has now repurchased $1.2 billion of shares this year. It also doubled its repurchase authorization to $4 billion earlier this year to opportunistically buy back more shares.
An enticing payout
Another attractive feature of Diamondback Energy is its dividend. The oil company pays a base dividend of $0.75 per share each quarter. That gives it a 2.1% dividend yield at the recent stock price, which is higher than the S&P 500's 1.6% dividend yield.
In addition to that base dividend payment, which Diamondback has grown at a peer-leading rate over the years, it also makes variable dividend payments. The company's most recent was $1.51 per share for Q3. Add in the base payment, and Diamondback's annualized dividend yield was well over 5% at that level. Meanwhile, its prior variable dividend was even higher, giving it nearly a 10% yield at the time. Diamondback made a smaller variable dividend payment in the most recent quarter to repurchase more of its cheap shares.
Adding more fuel to the cash-flow engine
Diamondback Energy has also used its gushing cash flows to expand its operations. The company is spending $3.3 billion in cash and stock to buy FireBird Energy and Lario Permian. The deals are immediately accretive to all its important financial metrics, including free cash flow per share. They will also boost its oil and gas production while extending its drilling inventory in the Midland Basin.
Overall, Diamondback expects the acquisitions to provide it with an incremental $570 million of free cash flow next year. That's a needle-moving amount of money that should enable Diamondback Energy to grow its free cash flow even if oil prices head lower. It would give the oil company more money to pay dividends, repurchase shares, and continue expanding.
A great oil stock
Diamondback Energy is a cash-gushing oil stock that trades at a dirt-cheap price these days. It's taking advantage of that situation by repurchasing some of its shares even as it pays an attractive dividend and makes value-enhancing acquisitions. Those deals should give it the fuel to continue growing its cash flow next year. Put all these features together, and Diamondback Energy is one of the top oil stocks to buy this month.
