In addition to impressive stock price appreciation, long-term investors in Chevron (CVX) have enjoyed significant dividend growth over the past eleven years as well. In 2000, shares of Chevron paid out $1.30 in annual dividends relative to $3.99 in annual earnings, for a payout ratio of 32.50%. Based on 2011 estimates, Chevron will pay out $3.06 worth of dividends backed by $12.75 in earnings, for a payout ratio of 24%. Looking at the big picture, it seems that the safety and stability of Chevron’s has been impressive—very few companies that raise their dividend from $1.30 to $3.06 over an eleven-year stretch are able to simultaneously lower their payout ratio from the 30% range to the lower 20s.
But investors had to endure a rough patch of time on their way to realizing this robust dividend growth—from 2000 to 2002, the dividend was only raised by a little more than 3% each year, and more importantly, Chevron paid out 85.80% of its earnings in 2001, and 259% of its earnings in 2002. Sure, we know now that oil has skyrocketed to around the vicinity of $100 per barrel, but most people probably would have considered you absurd for suggesting such a thing in the early 2000s when oil traded between the $18-$28 range. In this case, the benefit of hindsight makes it clear that Chevron has done just fine—but if you were a retiree living off of Chevron dividends in 2002 when you saw that the company was paying out 2.5x earnings in the form of dividends, would you have had the wherewithal to hold on?
Most income-focused investors create rules to determine when to sell—for instance, if the payout ratio becomes too uncomfortably high or if the dividend growth is flat/gets cut. With the exception of 2009, Chevron’s payout ratio has been in the 20-30% range every year since 2004, rewarding investors who have chosen to stick it out with the company.
The rewards of sticking with Chevron are clear—you could have scooped up shares of CVX in the low $30 range from 2000 to 2003, and within the next eight years, the stock price tripled and Chevron’s current $0.78 quarterly dividend would give then-investors a 10% plus dividend yield on initial cost, without dividends reinvested (depending on your buy-in price, your dividend yield on initial investment cost would now be between 13% and 16% annually). But, of course, skittish investors scared off during the early part of the decade would have hamstrung their returns by most likely selling when the payout ratio hit 85% or 259%.
Without a doubt, the long-term price of oil will heavily determine the earnings growth and dividend growth that investors can expect from Chevron going forward. From 2008 to 2009, Chevron’s earnings per share fell from $11.67 to $5.24 as gas prices lost over half of their value. I don’t expect oil to trade below $80-$90 per barrel for any extended time going forward, but if it does, then Chevron will most likely cease to deliver the kind of dividend growth that investors have enjoyed over the past eight years. My general thesis when it comes to oil is that a recovering American economy, coupled with rising demand from rising industrial powers, ought to keep the price of oil above (or perhaps even well above) the $90 mark that ensures a margin of safety of Chevron’s earnings and dividends to grow.
Chevron has managed to raise its dividend by 11% annually over the past five years, and while I would not count on that type of dividend growth to continue in the medium 5-7 year term, I do think it’s reasonable to project around 6.5-8% annual growth from Chevron’s dividend. At today’s price of about $94 per share, investors can get in at a 3.45% dividend yield, which seems to offer a very realistic potential to rise with time.
Over the past twenty to thirty years, energy companies have tended to vacillate between periods of anemic dividend growth (think 2-4% range) during the 1990s and explosive dividend growth of over 10% during favorable 5-10 year stretches (think 2004 to present). With companies like ExxonMobil (XOM), Chevron, and ConocoPhillips (COP) representing the best in breed of the sector (granted Conoco’s impending stock spinoff may make this point moot), you will most likely do well to devote 5-15% of your overall portfolio to Big Oil with the expectation of receiving rising dividends in the future. If investors can maintain the diversification necessary to get through the periods of lower dividend and earnings growth when oil is out of favor, then the prospect of long-term income growth with the dividends of companies such as Chevron seem promising.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
