It's hard to argue against the attractiveness of getting paid to do nothing. That's why ultra-high-yield dividend stocks like Devon Energy (DVN 0.19%), a leading upstream energy company, garner such considerable attention from income investors.
But simply buying these stocks to generate strong passive income is hardly a sound investing strategy. It's quite possible that the alluring high yield is masking troubles with the underlying business. In the case of Devon Energy, two Fool.com contributors present both sides of the argument.
Grab this passive-income powerhouse while it's hanging on the discount rack
Scott Levine: Look at Devon Energy's history of dishing out dividends to investors and you'll find that the payout ebbs and flows. This stems from the company's policy of returning both a fixed amount and a variable amount to investors -- a policy that was an industry first when it began in 2021. On top of the fixed amount of $0.20 per share that comprises the dividend each quarter, Devon Energy plans on returning up to 50% of free cash flow.
This approach is especially alluring because it illustrates that while the company is returning a hefty amount to investors, management is acting judiciously, working to ensure the company's financial health. By retaining a large portion of its free cash flow, the company is able to reduce its debt and reinvest in the business with acquisitions and improvements in its infrastructure. And it seems to be working, as the company has an investment-grade balance sheet. Further evidence of its financial well-being comes in the form of its conservative approach to leverage. At the end of the third quarter of 2023, Devon Energy had a ratio of net debt to earnings before interest, taxes, depreciation, amortization, and exploration expenses of 0.7.
Devon Energy's stock looks particularly appealing right now from a couple of different perspectives. For one, the stock is valued at 7.6 times trailing earnings, representing a steep discount to its five-year average P/E ratio of 23.9. For those who prefer a cash-flow valuation, shares still seem attractively priced. Currently, shares are valued at 4.3 times operating cash flow -- lower than their five-year average ratio of 5.1.
Because its dividend is sensitive to the ebbs and flows in oil prices, income investors should recognize that this income stock won't provide steadily increasing dividends. Nonetheless, investors can certainly look to Devon Energy as a way to diversify their passive income portfolio with a stock that will provide hefty returns when energy prices soar.
Investors need to think carefully before buying Devon Energy
Lee Samaha: For the record, I agree that Devon Energy is an attractive stock for investors. However, it makes no sense not to explore the bear case before buying a stock, and Devon Energy might not suit all investors.
It's no secret that the fortunes of oil and gas exploration and production companies tend to be led by oil prices. That's a fact implied in a slide on Devon's third-quarter earnings presentation outlining its free-cash-flow and dividend sensitivity about the price of oil. There's nothing wrong with this, but it is a fact to consider for investors holding a portfolio overloaded with energy-related stocks.
In addition, while investors focus on oil, it's essential to recognize that the collapse in gas prices of the last year played a significant role in the lowering of Devon Energy's dividend through 2023.
Moreover, the chart above shows another aspect of Devon's dividend you must consider. While many income-seeking investors are happy to hold it for the dividend and the promise, at the least, of its base dividend of $0.20 (which would yield 1.85% at the current price), the reality is the market has historically traded the stock in line with the price of oil. As such, historical trading does not support the idea that the dividend yield will support the share price.
All told Devon Energy is a fine and worthy candidate for investors looking for exposure to energy, but be prepared for some potential share price volatility if you buy it.
Should you buy these stocks now?
There's no dividend stock that's perfect for every investor. Those comfortable with the fact that Devon Energy's dividend will dip when oil prices drop, however, may want to drill down deeper into the advantages of counting this exploration and production company among their holdings. On the other hand, investors who are more concerned with generating steady passive income will want to eschew Devon Energy and consider a more reliable company like those that distinguish themselves as Dividend Kings.
