The stock market is full of exciting young companies with massive growth potential, as well as veteran companies that have been around for decades or even over a century. The investment thesis for stocks can vary widely based on their business model. But the inherent goal of every company is to maximize shareholder value over the long term.
Companies with limited growth prospects tend to use dividends and stock buybacks to drive shareholder returns. Dow (DOW 0.48%) and Kinder Morgan (KMI +0.13%) have limited spending plans, which ensures free cash flow (FCF) can easily cover the dividend. Meanwhile, Devon Energy (DVN +0.24%) directly passes along its profits to shareholders through a variable dividend. Here's what makes each high-yield dividend stock a great buy now.
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1. Dow is coming off a great year and can handle an industrywide downturn
Perhaps one of the least talked about reliable dividend stocks in the Dow Jones Industrial Average is Dow itself. The name is a bit of a misnomer, as Dow, the chemical company, has nothing to do with the "Dow" in the index name. However, Dow is in the index for good reasons.
The company is a major producer of commodity chemicals that are used across the economy. Dow's business model relies on cost efficiency and scale, as well as a growing economy that demands more inputs. Therefore, Dow is vulnerable to an economic downturn.
However, Dow has a lot going for it. In the short term, oil prices have come down to levels not seen since December 2021 -- which is good news for Dow because oil is the main basic feedstock it buys to make chemical products. Dow is also coming off its highest year of revenue and free cash flow (FCF) since spinning off from DowDuPont in 2019.
Dow has been hard at work paying down debt and bolstering its balance sheet. It also generates plenty of extra FCF to afford its dividend, which yields an attractive 5.5%.
Dow is an industry-leading business that has been through plenty of cycles before. If a global economic slowdown does occur, the company is in great shape to endure. And if oil prices remain lower and the economy recovers, Dow is also poised to capitalize on that growth.
NYSE: DOW
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2. Kinder Morgan is investing in U.S. natural gas exports
Unlike other oil and gas stocks, Kinder Morgan isn't as affected by gyrations in oil and gas prices. That's because its network of infrastructure assets is tasked with transporting and storing natural gas, oil, CO2, and other products -- not producing or selling them.
Since cutting its dividend in 2016, Kinder Morgan has been hard at work restoring investor trust. It has improved its balance sheet, reduced its debt, and made meaningful increases to its dividend as well. It has also cut its investments and been stricter about spending.
However, in recent years, Kinder Morgan has been particularly interested in the rise of U.S. liquefied natural gas (LNG) exports. Instead of solely relying on energy buyers that are close by, LNG opens the door to the global market and allows the U.S. to produce far more natural gas than it consumes. A growing LNG market means more natural gas production, more pipelines, and more storage -- which is an opportunity for Kinder Morgan.
Kinder Morgan's biggest long-term threat is a permanent decline in the use of natural gas as developed nations shift toward renewable energy. The value and use of Kinder Morgan's assets depend on growing or at least stagnant oil and gas demand. For now, the rise of LNG seems to indicate increased global natural gas consumption in lockstep with increased renewable energy investment -- meaning both industries can succeed at the same time.
Kinder Morgan's 6.7% dividend yield is backed by gobs of free cash flow. The company should be able to continue raising the dividend for years to come.
NYSE: KMI
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3. Devon Energy stock is a bargain
As an upstream exploration and production (E&P) company, Devon energy is sensitive to changes in oil and gas prices. So, it's not too surprising that the stock has pulled back from its 2022 highs. But the extent of the Devon Energy sell-off is quite a bit more extreme than other E&Ps. In fact, Devon Energy is now down over 20% year to date.
The sell-off seems unwarranted, given how efficient Devon Energy's portfolio is. The company's 2023 capital spending plan is based on West Texas Intermediate (WTI) crude oil (the U.S. benchmark) averaging at least $40 this year -- which gives the company a large margin of error for oil prices to come down.
Despite this advantage, Devon is unlikely to match the $5.17 per share dividend payments it made in 2022, considering last year was an outlier. Devon's quarterly dividend changes based on its FCF and earnings. For example, it only paid $1.97 in dividends in 2021. The first quarterly payment in 2023 was $0.89 per share, higher than any 2021 quarterly payment but lower than any 2022 payment. It's too early to tell, but it would seem reasonable to expect Devon to pay between $3 and $4 per share in 2023 dividends. Even $3 per share in dividends would represent over a 6% forward dividend yield.
Another issue for Devon is that the stock isn't as cheap as it looks since its forward earnings and FCF are likely to be lower than its trailing-12-month figures. So its price-to-earnings ratio of 5.4 and price-to-FCF ratio of 9.4 are misleading.
Even still, Devon Energy is in a position where its earnings and dividend could be half of what they were in 2022, and it would still be a high-yield value stock with a bargain-bin valuation. For that reason, the sell-off in Devon Energy is a buying opportunity.
NYSE: DVN
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Three passive income powerhouse stocks for patient investors
Dow, Kinder Morgan, and Devon Energy are all impacted by oil and gas in different ways. But all three stocks are similar in that they have inexpensive valuations, high dividend yields, and attractive asset portfolios. Buying all three stocks is a great way to get a high overall passive income stream while also diversifying exposure across different segments of the integrated oil and gas value chain.
