2 high yield energy actions to buy Hand Over Fist and 1 to avoid

For dividend investors, one of the most important things to know about the energy sector is that it is highly volatile. That means dividend-paying energy stocks should go through a little extra vetting before they’re added to your portfolio.

A great example of the problem income investors face when looking for energy investments is Devon Energy (DVN 2.36%). Meanwhile, Chevron (CVX 1.30%) and Enterprise product partners (EPD 0.69%) are solid examples of the gems you can unearth in the energy sector when you do a little digging.

Devon Energy’s dividend history isn’t shocking

Devon Energy is what is known as an upstream company, meaning it produces oil and natural gas. In this case, the company operates exclusively in the US onshore space, but that is not the most important factor here.

What is important to understand is that its top and bottom results are driven almost entirely by energy prices. Oil and natural gas prices are highly volatile, so Devon’s financial results are also highly variable.

This is not a bad thing, in itself. It’s pretty much par for the course when looking at an upstream company. For dividend investors, however, there is an upside. Devon’s dividends are variable, with the final payout tied to the company’s financial results.

Even though the dividend yield is quoted at 4.4% on major online quote services, investors should expect the actual income received to vary widely over time. In some ways, the variable dividend policy is a good way to ensure that shareholders are rewarded when energy prices are high, but the downside is that dividend cuts are inevitable.

For most income investors, Devon Energy will not be a good stock to own.

Chevron is a reliable dividend payer

If you’re looking for a reliable dividend payer with a long history of annual increases behind it, you’ll probably be better off with Chevron. For starters, it’s much more diverse. Its business spans upstream, midstream (pipelines) and downstream (chemicals and refining).

The company’s energy portfolio is also globally diversified. And it happens to be one of the largest energy companies on the planet, with a market cap of $260 billion. Chevron’s dividend yield is also around 4.4%.

The energy company has increased its dividend annually for 37 consecutive years despite the sector’s inherent volatility. A big part of the story here is its strong balance sheet, with a debt-to-equity ratio of just 0.14 times.

That would be strong for any company, but it gives Chevron the freedom to take on debt during industry downturns so it can prop up its business and dividends. When energy prices rebound, as they always have in the past, the debt is paid in preparation for the next energy sale.

If you’re looking for an energy producer with a reliable dividend, Chevron is one of the best options you’ll find.

Enterprise is a high yield boring producer

If Chevron’s exposure to oil and natural gas production is a little too worrisome for you, there are still some energy options. One of the most trusted is Enterprise Products Partners, a master limited partnership (MLP) that operates a large portfolio of midstream infrastructure assets.

It generally charges fees for the use of these assets, so the price of oil and natural gas flowing through its system isn’t all that important to its financial results.

This is evidenced by the fact that the company has increased its distribution annually for 26 consecutive years. And there is much more to appreciate here. Specifically, the balance sheet is investment-grade, and cash flow covers distribution at a hefty 1.7 times. There is plenty of room for adversity before a distribution cut is on the table.

That said, Enterprise’s significant distribution yield of around 7% is likely to make up the bulk of the return over time. This is because there are limited growth prospects in the midstream sector.

But consolidated acquisitions, expansions of existing assets, small core capital projects and regular rate increases on its existing portfolio will likely lead to slow and steady growth over time. And that, in turn, should support continued distribution growth.

The best options for energy income

Dividend investors need to understand the impact that high volatility in the energy sector will have on their investments. Both Chevron and Enterprise have proven they know how to handle the industry’s ups and downs while continuing to reward investors over time.

That said, Devon Energy is not a bad company, but it has chosen a very different approach to dividends, which inherently means shareholders will see dividend cuts. If you are looking for a reliable income stream in the energy sector, Chevron and Enterprise will be much better choices.