The Energy sector is infamous for being notoriously volatile, with sudden positive surprises and crashes. While wild price moves have always been integral to investment in oil and natural gas, the quantum of uncertainty has increased manifold in recent years, especially post-COVID.

In an erratic energy market setting, investing in high-quality dividend stocks like HF Sinclair (DINO Quick QuoteDINO - Free Report) , ExxonMobil (XOM Quick QuoteXOM - Free Report) and Diamondback Energy (FANG Quick QuoteFANG - Free Report) might fetch you promising returns.

Use Dividend to Shield From Unpredictable Energy Prices

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 in March last year and finally around $80 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 hit $10 per MMBtu in 2022 for the first time since 2008 before falling to the current $3 level. Diverse factors ranging from demand/supply fundamentals to economic events to geopolitical/weather 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.

How to Pick the 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 recommend stocks with a payout ratio of less than 60 and a dividend yield of at least 2%. Moreover, these companies have hiked 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 better yields than the S&P 500. A representative of the broader market, the index currently yields 1.59%. 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 a 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.

HF Sinclair Corporation: A producer and marketer of gasoline, diesel fuel and other specialty products, HF Sinclair pays out a quarterly dividend of 40 cents ($1.60 annualized) per share that gives it a 3% yield at the current stock price. The Zacks Rank #3 (Hold) company’s payout ratio is 14, with a five-year dividend growth rate of 4.78%. (Check HF Sinclair’s dividend history here)

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

DINO is valued at some $10.7 billion. The Zacks Consensus Estimate for HF Sinclair’s 2022 earnings has been revised 5.5% upward over the past 90 days. The downstream operator has a trailing four-quarter earnings surprise of roughly 695.8%, on average. DINO shares have gained 61.5% in a year.
 

ExxonMobil: ExxonMobil 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. XOM’s dividend of 91 cents per share ($3.64 annualized) represents a 3.29% yield. The Zacks #3 Ranked ExxonMobil’s payout ratio is 28, with a five-year dividend growth rate of 2.17%. (Check ExxonMobil’s dividend history here)

ExxonMobil is valued at some $455.5 billion. The Zacks Consensus Estimate for XOM’s 2022 earnings has been revised 5.4% upward over the past 90 days. ExxonMobil, headquartered in Irving, TX, has a trailing four-quarter earnings surprise of roughly 5.1%, on average. XOM shares have gained 54.2% in a year.
 

Diamondback Energy: Diamondback Energy is an independent oil and gas exploration & production company with its primary focus on the Permian Basin. FANG’s dividend of $2.26 per share comprises 75 cents ($3 annualized) in regular payout, plus a variable cash component of $1.51 apiece. The regular component represents a 2.08% yield. The #3 Ranked Diamondback’s payout ratio is 13, with a five-year dividend growth rate of 55.31%. (Check Diamondback Energy’s dividend history here)

Diamondback is valued at some $25.4 billion. For 2022, FANG has a projected earnings growth rate of 115.1%. Diamondback, headquartered in Midland, TX, has a trailing four-quarter earnings surprise of roughly 5.7%, on average. FANG shares have gained 24.1% in a year.