Devon Energy (NYSE: DVN) is a large U.S. oil and natural gas producer. After a period in the industry when growth was all the rage, management has shifted gears and is now focused on returning value to shareholders via dividends. The energy sector is inherently volatile, however, so Devon has chosen to institute a variable dividend policy. That's why a year of dividend cuts, including the most recent 32% reduction, shouldn't be at all surprising to shareholders.
It was a fun ride on the upside
Devon Energy's dividend was $0.30 per share in Q1 2021. By the end of that year, the quarterly payment was up to $0.84 per share. It continued to rise until Q3 of 2022 when it hit $1.55 per share. That's more than 5 times what it was at the start of 2021.
DVN Dividend Per Share (Quarterly) data by YCharts
That would have been one enjoyable ride for investors. However, there's an interesting fact that has to be discussed. West Texas Intermediate (WTI) crude prices, a key U.S. energy benchmark, were heading higher throughout most of that time frame. With a dividend policy tied to the energy company's financial results, it makes complete sense that the dividend would be steadily rising through this period. Basically, Devon Energy's top and bottom lines are driven by oil prices, and so with results heading higher, the dividend rose, too.
But take a look at the tail end of the graph above and you'll notice that WTI prices started to decline in the third quarter of 2022. The dividend still went up because the payment is based on past performance, not the expectation of future performance. However, the dividend upsurge stopped in Q3 2022.
The dividend downside can sting
The chart below shows the rise in WTI and Devon Energy's dividend and the subsequent decline in both. Given the variable dividend policy, this is exactly what investors signed up for. As long as Devon was doing well, investors could expect strong dividends. When performance turned lower, tracking along with WTI prices, the dividend would end up getting trimmed.
DVN Dividend Per Share (Quarterly) data by YCharts
From the peak in the third quarter of 2022, the dividend payment has now been cut a massive 68%. Investors that bought the stock based on its dividend yield alone (which at one point was in the double digits) would probably be shocked and upset by the decline. Clearly, this is not a stock that dividend investors looking for consistent dividends should be considering. Basically, when you look at the big picture, the dividend was slashed because oil prices declined.
As long as oil prices keep heading lower, the dividend will likely follow suit. But when WTI prices stabilize, Devon Energy's dividend should, too, with likely a quarter's lag time or so. And if oil prices head higher again, the dividend should as well, again with a slight lag. It is how the company's dividend policy is supposed to work.
Why bother with a variable dividend?
For most income-focused investors, Devon's variable dividend policy probably won't be attractive. But it is a fairly straightforward way to return value to shareholders in a business that tends to rise and fall along with a volatile commodity like energy. And it might actually appeal to more active investors that use oil and natural gas for things like heating and transportation. Just as your costs are likely to be going up, so would Devon's dividend. That provides something of a hedge against energy costs, assuming you can stomach the inherent volatility of a variable dividend policy.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
