While the Energy sector can generate great returns when commodity prices go up and profits skyrocket, it is also exposed to heavy selling pressure when realizations crater. In other words, the oil and gas business is inherently cyclical, with delicate supply/demand balances, among others, determining their fortunes.
 
Amid the specter of magnified gains and losses, investing in high-quality dividend stocks like Canadian Natural Resources (CNQ Quick QuoteCNQ - Free Report) , Chevron (CVX Quick QuoteCVX - Free Report) and Imperial Oil (IMO Quick QuoteIMO - Free Report) might fetch you stable, promising returns.

Focus on Dividend Growth Investing to Offset Energy Volatility

From the depths of minus $38 a barrel during the height of the pandemic in April 2020 to a 14-year high surge of above $130 per barrel this March and finally around $90 now, crude has been on a roller-coaster ride over the past few years. It’s not any different for natural gas. The fuel slumped to a 25-year low in June 2020 but recently hit $10 per MMBtu for the first time since 2008. Diverse factors ranging from demand/supply fundamentals to economic events to geopolitical shocks influence commodity price realizations.  

As evident from the energy market story, stocks can take a sudden turn for the good (or bad), making stock picking a risky game. Every good stock also has its bad day, which adds to the risk. With uncertainty ruling the markets, it is not surprising that dividend investing has emerged as one of the most popular investing themes.

Dividend stocks are always investors’ preferred choices as they provide steady income and cushion against market risks. These stocks are generally less volatile in nature and hence, are dependable when it comes to long-term investment planning. They not only offer higher income but also protect against equity market risks.

Dividend stocks are safe bets to create wealth, as the payouts generally act as a hedge against economic uncertainty and simultaneously provide downside protection by offering sizable yields on a regular basis. Finally, dividend growth can also help investors to offset some of the value destruction of the high inflationary environment prevailing at the moment.

A Careful Stance Leads to Best Dividend Stocks

Although the benefits of dividend investing cannot be stressed enough, one should keep in mind that not every company can keep up with its dividend-paying momentum. Hence, a cautious strategy needs to be followed to select the best dividend stocks with the potential for steady returns.

To guide investors to the right picks, we are recommending stocks with a payout ratio less than 60 and dividend yield of at least 2%. Moreover, these companies have grown their dividends over the past five years.

Calculated by dividing dividend per share by earnings per share, the payout ratio indicates how comfortably a firm can pay the dividend from its earnings. It is one of the key metrics that dividend growth investors consider when looking for potential investments. A payout ratio below 60 looks quite sustainable and leaves enough scope for future dividend hikes.

With our objective to build a dividend income portfolio, we look for companies that at least have yields better than the S&P 500. A representative of the broader market, the index currently yields 1.48%. While our yield criterion isn't very high, it’s at a level where the company can weather all kinds of commodity price environments and provide a reliable income stream to investors.

Finally, we only consider stocks that have consistent dividend, i.e., paying and increasing offerings over the past five years. It also acts as an indicator of what to expect from the company in the next few years on the payout front.

Our Choices

We have used the above criteria to narrow down three dividend-paying energy stocks.

Canadian Natural Resources: One of the largest independent energy companies in Canada, CNQ pays out a quarterly dividend of 75 Canadian cents, or around 57 cents per share, which gives it a 4.33% yield at the current stock price. The Zacks Rank #2 (Buy) company’s payout ratio is 30, with a five-year dividend growth rate of 19.5%. (Check Canadian Natural Resources' dividend history here)

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

CNQ is valued at some $63.2 billion. The Zacks Consensus Estimate for Canadian Natural Resources’ 2022 earnings has been revised 5.2% upward over the past 60 days. The Canadian enengy behemoth has a trailing four-quarter earnings surprise of roughly 15.5%, on average. CNQ shares have gained 61.1% in a year.
 

Chevron: Chevron is one of the largest publicly traded oil and gas companies in the world, which participates in every aspect related to energy — from oil production to refining and marketing. CVX’s dividend of $1.42 per share ($5.68 annualized) represents a 3.56% yield. The Zacks Rank #3 (Hold) Chevron’s payout ratio is 39, with a five-year dividend growth rate of 6%. (Check Chevron’s dividend history here)

Chevron is valued at some $319.3 billion. The 2022 Zacks Consensus Estimate for CVX indicates 125% year-over-year earnings per share growth. Chevron, headquartered in San Ramon, CA, has a trailing four-quarter earnings surprise of roughly 7.5%, on average. CVX shares have gained 65.8% in a year.
 

Imperial Oil: Imperial Oil is mainly engaged in oil and gas production, petroleum products refining and marketing, and chemical business. IMO pays out a quarterly dividend of 34 Canadian cents/26 cents ($1.04 annualized) per share which gives it a 2.17% yield at the current stock price. The Zacks Rank #3 company’s payout ratio is 17, with a five-year dividend growth rate of 15.37%. (Check Imperial Oil’s dividend history here)

Imperial Oil is valued at some $30.8 billion. The 2022 Zacks Consensus Estimate for IMO indicates 179.1% year-over-year earnings per share growth. The Canadian oil giant has a trailing four-quarter earnings surprise of roughly 2.4%, on average. IMO shares have gained 71.4% in a year.