Dividend paying stocks like Devon Energy Corporation (NYSE:DVN) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.
A 1.4% yield is nothing to get excited about, but investors probably think the long payment history suggests Devon Energy has some staying power. The company also returned around 26% of its market capitalisation to shareholders in the form of stock buybacks over the past year. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.
Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable - hardly an ideal situation. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Devon Energy paid out 11% of its profit as dividends. With a low payout ratio, it looks like the dividend is comprehensively covered by earnings.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Unfortunately, while Devon Energy pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.
We update our data on Devon Energy every 24 hours, so you can always get our latest analysis of its financial health, here.
From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. Devon Energy has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. Its dividend payments have fallen by 20% or more on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was US$0.64 in 2009, compared to US$0.36 last year. This works out to be a decline of approximately 5.6% per year over that time. Devon Energy's dividend hasn't shrunk linearly at 5.6% per annum, but the CAGR is a useful estimate of the historical rate of change.
We struggle to make a case for buying Devon Energy for its dividend, given that payments have shrunk over the past ten years.
Dividend Growth Potential
Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Devon Energy has grown its earnings per share at 39% per annum over the past five years. The company is only paying out a fraction of its earnings as dividends, and in the past been able to use the retained earnings to grow its profits rapidly - an ideal combination.
To summarise, shareholders should always check that Devon Energy's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Devon Energy has a low payout ratio, which we like, although it paid out virtually all of its generated cash. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. Ultimately, Devon Energy comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 18 Devon Energy analysts we track are forecasting continued growth with our free report on analyst estimates for the company.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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