The energy sector is the best performing sector in 2022 and for good reason. Geopolitical events combined with years of underinvestment have resulted in an imbalance between supply and demand. When the economy is growing and oil and gas supplies are reliable, it’s easy to take the energy sector for granted. But without reliable sources of fuel, modern economies grind to a halt.
An increased focus on energy security sets the stage for a strong oil and gas sector that can grow alongside renewables. However, higher oil prices coupled with a possible recession are bad news for chemical companies that rely on oil inputs to make plastics and other products. Two high-yielding stocks that stand out now are Chevron (CLC -0.86%) Y dow (DOW -2.44%). Chevron is thriving and making record profits, while Dow stock has sold off and is trading at a very cheap valuation. This is what makes every dividend stock a great buy now.
1. The best specialty in oil and gas
Chevron shares have plunged along with the rest of the oil and gas industry in recent months as oil and gas prices have fallen on fears that demand will slow. The liquidation has pushed Chevron’s dividend yield back up to 3.9%. Even if oil and gas prices continue to fall, Chevron can still succeed because it has lowered its cost of production and strengthened its balance sheet for years.
It’s no exaggeration that Chevron is working flat out. One of the most amazing Chevron charts is its net income for the last 12 months (TTM).
Consider that Chevron went from a record loss of nearly $12 billion in 2020 to an all-time-high TTM net income in just two years.
The company’s earnings and free cash flows (FCF) have outpaced the rise in its share price, even though Chevron’s shares are up 29% year-to-date. The result is that Chevron shares are the cheapest in five years even though the share price is near a five-year high.
Earnings could decline from here given the movement in oil and gas prices. But what the chart above shows is that even if earnings and FCF are cut by a third, Chevron stock would still be a fair value with a P/E ratio of around 15 and a price-to-FCF ratio of 15.
The dividend yield can also be used as a proxy for the valuation.
Chevron’s dividend yield peaked during the worst of the 2020 oil and gas crisis. Yet even now, the 3.9% yield is above the 25-year average yield thanks to years in which Chevron shares underperformed the broader market, along with steady dividend increases.
The company’s diversified business in upstream, midstream, downstream and global exposure gives it more stability than a pure producer. Despite relatively high oil and gas prices, Chevron and many of its peers have achieved only minor increases in production, choosing instead to benefit from high margins and use excess profits to invest in alternative energy, buy back shares and increase the dividend. The move seems sound, especially if the demand for oil and gas continues to fall.
In all, Chevron is arguably the best oil and gas stock to buy right now. And even if its earnings and FCF drop a bit, the stock is likely at a deep discount compared to its long-term average valuation.
2. A diversified chemical company with a very attractive dividend
Economic growth and strong consumer spending tend to benefit materials companies that make more money when their end markets are strong. Dow, which is one of the world’s largest chemical companies, manufactures adhesives, sealants, polyethylene, polyurethanes, silicones, elastomers, plastomers, amines, chelates, and other products and technologies for major industries such as construction, construction, infrastructure, chemical manufacturing, industrial applications, automotive, films, tapes, shipping release liners, and even beauty and personal care chemicals.
Dow is facing two headwinds right now. The first is that the economy could be contracting, which could lead to lower consumer spending and lower profits in many of its core markets. The second is that higher oil and gas prices increase input costs for Dow, which uses oil as a feedstock in its chemical plants. However, these headwinds appear to be priced in, as Dow shares are now down 39% from their 52-week high.
The company has not increased its dividend since it was spun off from du pont de nemours Y corteva in 2019. But with a 6.3% dividend yield, Dow already produces a sizable stream of passive income. In 2021, the company earned $8.38 in diluted earnings per share, $6.26 in free cash flow (FCF) per share, and paid dividends of $2.80 per share. Put another way, the company could see earnings fall by two-thirds and FCF fall by half, and still be able to pay its dividend. Add it all up and you have a high-yielding dividend stock that now looks like a great buy.
A dynamic duo for an income-oriented investor
Chevron combines high yields and a history of payments, while Dow stocks provide an enviable amount of passive income from the dividend alone. In the long term, both companies are likely to face earnings volatility due to fluctuations in commodity prices and the broader economy.
Dividends help alleviate volatility by allowing investors to hold the underlying stock and earn passive income without selling shares. For patient investors looking for two industry-leading companies, Chevron and Dow look like a great overall value now.