At the time I am writing, Chevron stock crossed below the $100 per share threshold (in fact, the company hit a low price of $98.88 today). The current yield of the stock is around 4.3%. That starting base is particularly exceptional when you factor into account how quickly it tends to grow. For every share of Chevron that you owned in 1998, you got to collect $1.22 in dividends. Now, you get to collect $4.29 per share. The long-term dividend growth rate, while sporadic on a year-to-year basis, has a tendency to converge around the high single-digit rate: over the past five years, Chevron has raised its dividend at 9.5% annually. Over the past ten years, the rate is 9.0% annually. And over the past twenty, a little over 8.5% annually.
The reason why it can be difficult for some people to get a good entry price with the cyclical blue chips like Chevron, Exxon, and Emerson Electric is that the moments when it is the cheapest the dividend growth rate is the slowest and the earnings are declining rapidly.
To use the last bear market cycle for oil prices (from the top of 2000 to the low of 2002), Chevron saw its profits of $3.99 in 2000 fall to $1.55 in 2001 then to $0.54 in 2002. As the earnings collapsed, the dividend growth was predictably anemic—the dividend only grew from $1.30 to $1.40 from the start of 2000 to the end of 2002. At its worst, Chevron was paying out $1.40 in dividends while making $0.54 in profits, paying out 2.5x more in dividends than it was making in profits during the year. The dividend crossed the 4% yield mark, with the stock coming below $34.
Here is the crazy thing: The valuation wouldn’t have seemed cheap, if you thought about the stock on a standard P/E basis that we often associate with non-cyclical companies. The P/E ratio was 62.9x earnings. The plummeting profits wouldn’t have told you that Chevron was an intelligent buy—you would have had to look to production gains, dividends paid, and expected profit growth with higher long-term commodity prices to see that Chevron would have made sense at that time.
And yet, the investor that did that—bought Chevron at 62x profits that required some wisdom to see that they were artificially deflated—would have hit the dividend jackpot. Each share bought at $34 in 2002 would have paid $34.53 in cumulative dividends during the 2002-2012 time period.
That isn’t to say that Chevron’s allocation policies are perfect—today, they announced that they were suspending the stock buyback for the rest of 2015 in response to oil prices falling more than half since this past summer. Part of me doesn’t fault them for the decision—dividends need to be paid, the $14.5 billion in cash on hand will likely need to go towards acquisitions and capital spending (even though Chevron announced that it was cutting its capital spending by 13%, it is still spending over $30 billion to roll out new liquefied natural gas projects).
However, the news does echo my long-standing criticism of stock buybacks, particularly for cyclical companies—when the earnings are high, and the stock price is high, the buybacks are plentiful. When profits and subsequently stock prices drop, and stock buybacks could be at their most effective, the well tends to dry up. Chevron was buying back stock in the $130s, but now that the stock is going down below $100, the buybacks are stopping when their effectiveness would be increasing. While I’m not a fan of the move, it’s not enough to deter from seeing Chevron below $100 as a very intelligent value blue-chip stock purchase, all things considered.
The stock is still diversified enough to make around $20 billion in profits. The dividends, reinvested at this lull point, have a coiled spring effect for when oil prices rise and then you get that $4.28 dividend that will start growing at a faster clip. My infatuation with Chevron, seemingly at the expense of Exxon and Phillips 66, is an extension of the Goldilocks principle where Chevron is just right. Phillips 66 probably has better earnings per share growth and even dividend growth potential, but it’s of slightly less robust quality. Exxon is one of the top dozen highest quality firms in the world—I think buying shares of Exxon at $87 qualifies as very intelligent behavior as well—but Chevron’s quality is close enough and it gives you a starting dividend yield a point higher. The ride may be bumpy—I have no idea how earnings and dividends will play out in the next few years—but the dividends that will pile up over the coming decade or two from this price point ought to be quite impressive.