Don’t Fall for These 3 Dividend Stocks: Cuts Are Coming

Devon Energy (NYSE: DVN) has a nearly 5% dividend yield. Pioneer Natural Resources (NYSE: PXD) yields about 4.3%. And Diamondback Energy (NASDAQ: FANG) has a roughly 4.2% yield.

Those are pretty attractive yields given that the S&P 500 Index is only yielding around 1.3% today, and the average energy stock pays 3.2%, using the Vanguard Energy Index ETF as a proxy.

There’s only one problem: You can expect Devon, Pioneer, and Diamondback to cut their dividends.

Energy is a volatile sector

Those three are all energy producers, operating in what is known as the upstream segment of the broader energy sector. They are highly volatile businesses because the oil and natural gas they produce drive their top and bottom lines.

Oil and natural gas are prone to swift and dramatic price swings. There are all sorts of reasons for this, including the impact of supply and demand, changes in world economic growth, and even geopolitical conflict.

But it doesn’t really matter why oil and natural gas prices weave and bob; as an investor, you simply have to go in knowing that volatility is the norm. And that has the exact impact you would expect on Devon, Pioneer, and Diamondback since the only thing they do is produce oil and natural gas.

That said, each of these dividend payers has chosen to adopt a dividend policy that rewards investors when energy prices are rising. They each have a “base plus variable” dividend policy that is tied to their financial performance. The base dividend ensures some stability in its payout. That’s actually a pretty good way to ensure that investors directly benefit from high oil and natural gas prices, since higher energy prices lead to dividend increases.

But there’s a trade-off. When energy prices fall, the variable part of the dividend gets cut. So by design, Devon, Pioneer, and Diamondback are going to fall short if you buy any of them believing that the yield you see is a reliable indicator of the future income you will collect from owning them. The dividend yield in each of the company profile images here shows the yield of the base dividend. That should give you a better idea of what these payouts look like without the variable dividend.

What goes up…

The chart below — with the price of West Texas Intermediate (WTI) crude, a key industry benchmark, and the dividend histories of Devon, Pioneer, and Diamondback — shows very clearly what the variable dividend policies mean in real life. As WTI rose, so, too, did the dividend payments made by this trio of energy producers. But when oil prices started to fall — well, the dividends went along for the ride.

DVN Dividend Per Share (Quarterly) Chart

This is exactly what you would expect given their dividend policies. And to be fair, the dividends have been heading higher again along with energy prices. That will probably get some dividend investors excited about the future income prospects here.

But don’t fall for this trap if you are looking for reliable dividend payers. By design, Devon, Pioneer, and Diamondback are inherently unreliable.

That doesn’t mean that they are bad companies. That’s something you need to decide on a company-by-company basis by examining their unique business fundamentals. But the volatile nature of energy prices means that dividend cuts are inevitable as long as they have variable dividend policies in place.

Just don’t fall for these yields

If you are looking at the energy sector in an attempt to find a high-yield dividend stock, you will probably see Devon, Pioneer, and Diamondback pop up on your screens. Their yields are currently elevated relative to the broader energy sector.

But that’s something of a mirage based on the way in which they have designed their businesses. A big yield that doesn’t last won’t be a worthwhile investment for most dividend investors trying to live off the income from their portfolios. Devon, Pioneer, and Diamondback are meant for a different kind of investor.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends Pioneer Natural Resources. The Motley Fool has a disclosure policy.

Don’t Fall for These 3 Dividend Stocks: Cuts Are Coming was originally published by The Motley Fool