While the Energy sector can generate great returns when commodity prices go up and profits skyrocket, it is also exposed to heavy selling pressure when realizations crater. In other words, the oil and gas business is inherently cyclical, with delicate supply/demand balances, among others, determining their fortunes.
 
Amid the specter of magnified gains and losses, investing in high-quality dividend stocks like Canadian Natural Resources (CNQ Quick QuoteCNQ - Free Report) , Chevron (CVX Quick QuoteCVX - Free Report) and Imperial Oil (IMO Quick QuoteIMO - Free Report) might fetch you stable, promising returns.

Focus on Dividend Growth Investing to Offset Energy Volatility

From the depths of minus $38 a barrel during the height of the pandemic in April 2020 to a 14-year high surge of above $130 per barrel in March last year, crude has been on a roller-coaster ride.

Of late, the going has been particularly tricky for “black gold.” Even Saudi Arabia’s surprise decision to slash output by an additional one million barrels per day from next month could not stop oil from slipping back to below $70 a barrel.

It’s not any different for natural gas. The fuel slumped to a 25-year low in June 2020 but hit $10 per MMBtu for the first time since 2008 in August last year. Now, it is struggling to hold above the $2 threshold as tepid weather-related usage continues to impact the commodity’s consumption.

As evident from the energy market story, stocks can take a sudden turn for the good (or bad), making stock picking a risky game. Every good stock also has its bad day, which adds to the risk. With uncertainty ruling Wall Street, it is not surprising that dividend investing has emerged as one of the most popular stock market themes.

Dividend stocks are always investors’ preferred choices as they provide steady income and cushion against market risks. These stocks are generally less volatile in nature and hence, dependable when it comes to long-term investment planning. They not only offer a higher income but also protect against equity market risks.

Moreover, dividend stocks are safe bets to create wealth, as the payouts generally act as a hedge against economic uncertainty and simultaneously provide downside protection by offering sizable yields on a regular basis. Finally, dividend growth can also help investors to offset some of the value destruction of the high inflationary environment prevailing at the moment.

A Careful Stance Leads to Best Dividend Stocks

Although the benefits of dividend investing cannot be stressed enough, one should keep in mind that not every company can keep up with its dividend-paying momentum. Hence, a cautious strategy needs to be followed to select the best dividend stocks with the potential for steady returns.

To guide investors to the right picks, we are recommending stocks with a payout ratio of less than 60 and a dividend yield of at least 2%. Moreover, these companies have hiked their dividends over the past five years.

Calculated by dividing dividend per share by earnings per share, the payout ratio indicates how comfortably a firm can pay dividend from its earnings. It is one of the key metrics that dividend growth investors consider when looking for potential investments. A payout ratio below 60 looks quite sustainable and leaves enough scope for future dividend hikes.

With our objective to build a dividend income portfolio, we look for companies that have at least better yields than the S&P 500. A representative of the broader market, the index currently yields 1.62%. While our yield criterion isn't very high, it’s at a level where the company can weather all kinds of commodity price environments and provide a reliable income stream to investors.

Finally, we only consider stocks that have a consistent dividend, i.e., paying and increasing offerings over the past five years. It also acts as an indicator of what to expect from the company in the next few years on the payout front.

Our Choices

We have used the above criteria to narrow down three dividend-paying energy stocks.

Canadian Natural Resources: One of the largest independent energy companies in Canada, CNQ pays out a quarterly dividend of 90 Canadian cents, or around 66 cents per share, which gives it a 4.79% yield at the current stock price. The Zacks Rank #3 (Hold) company’s payout ratio is 35, with a five-year dividend growth rate of 23.9%. (Check Canadian Natural Resources' dividend history here)

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
 

CNQ is valued at some $60.3 billion. The Canadian enengy behemoth has a trailing four-quarter earnings surprise of roughly 7.4%, on average. Calgary-based CNQ shares h(CVX Quick QuoteCVX - Free Report) ave lost 7.3% in a year.

Chevron: Chevron is one of the largest publicly traded oil and gas companies in the world, which participates in every aspect related to energy — from oil production to refining and marketing. CVX’s dividend of $1.51 per share ($6.04 annualized) represents a 3.84% yield. The #3 Ranked Chevron’s payout ratio is 32, with a five-year dividend growth rate of 6.1%. (Check Chevron’s dividend history here)
 

Chevron is valued at some $298.1 billion. The company’s expected EPS growth rate for three to five years is currently 14.3%, which compares favorably with the industry's growth rate of 11.6%. Chevron, headquartered in San Ramon, CA, has a trailing four-quarter earnings surprise of roughly 7.7%, on average. Chevron shares have lost 5.4% in a year.

Imperial Oil: Imperial Oil is mainly engaged in oil and gas production, petroleum products refining and marketing, and chemical business. IMO pays out a quarterly dividend of 50 Canadian cents (around 37 cents, or some $1.49 annualized) per share which gives it a 3.02% yield at the current stock price. The Zacks Rank #3 company’s payout ratio is 15, with a five-year dividend growth rate of 18.8%. (Check Imperial Oil’s dividend history here)
 

Imperial Oil is valued at some $28.8 billion. The company’s expected EPS growth rate for three to five years is currently 27.6%, which compares favorably with the industry's growth rate of 19.7%. The Canadian oil giant has a trailing four-quarter earnings surprise of roughly 13.1%, on average. IMO shares have lost 5.8% in a year.