At the start of 2014, Chevron stock traded at $114 per share. The price of oil was at $107 per barrel. The oil company was earning over $10 per share in profits, and was on target to pay $4.21 per share in dividends.
As you know, this was the eve of a multi-year decline in the price of oil that saw commodity prices fall from that $107 per barrel mark to a low of $27 which has since rebounded to the $50 range. At current prices, the earnings at Chevron ought to come in somewhere between the $4 and $5 mark, basically enough to cover the $4.28 per share dividend commitment but not much else.
During this time frame, investors have seen the price of Chevron stock fall 40% to a low of $69.58 on August 24th, and watched as upstream peer Conoco cut its own dividend by 66%. The atmosphere about the future of oil stocks considerably dampened, and it was easy for some to get caught up in the sky-is-falling doom that was pervading the sector.
But those who approached the oil decline with a well-diversified portfolio to encourage rational decisionmaking, kept a level head about the nature of large cyclical commodity businesses, and understood that the progeny of the original Standard Oil trusts have been through almost a dozen boom and bust cycles since 1882 are in considerably better shape.
They got to collect $4.21 per share in cash in 2014, $4.28 per share in 2015, and as of tomorrow, $2.14 through the first half of 2016. That’s $10.63 per share in cash if the money piled up in a brokerage account, or $12.23 per share in cash if the investor reinvested each Chevron dividend during the past 2.5 years in order to take advantage of the large dividend yield interacting with a depressed stock price (I assume a $103 reinvestment price for tomorrow’s dividend in my calculations.)
The net result just two and a half years later? A Chevron shareholder that paid $114 per share at the start of 2014 is now sitting on a stock that has recovered from the $69 low back up to $103 and have collected $12.23 in dividends over that time frame for a total economic value of $115.23.
Now, do people invest for the purpose of eking out 1% gains over a 2+ year time horizon? Of course not. But in light of the context, the Chevron experience is exceptional, and largely undocumented by the investing class media.
The price of oil is still only half of what it was at the start of the 2014 period, and yet, investors that reinvested have now earned a positive return while the commodity that is responsible for earnings has fallen in half. This is the appeal of owning mature companies that regularly return large gobs of cash to shareholders–your downside protection is extremely attractive so that even during periods of sector unrest you continue to own something that pumps out high amounts of cash and protects your net worth in a far superior way compared to what an intuitive expectation would suggest.
Over long periods of time, the secret with Chevron has been that the initial dividend yield is usually around the 4% range, the commodity production increases by about 3%, and the price of those commodities goes up by about 5% as well. The super long-term profile of Chevron is a 4% dividend yield coupled with 7.5% earnings and dividend growth, making this company the perfect dividend growth stock for those of you that desire large gobs of passive income in relation to a somewhat modest initial investment.
If you loaded up on $10,000 worth of Chevron stock in 1991, and chose to reinvest, you’d now be collecting $15,400 in cash dividends per year. Adjusted for inflation, the $10,000 initial investment is akin to $21,300 today. From a purchasing power standpoint, you’d be collecting 72% of your initial investment per year.
There’s this bizarre perpetual dissatisfaction with companies that operate in mature industries, have modest growth prospects, and have fully entered dividend mode. From this year through 2022, there is a high probability that someone who has owned $10,000 worth of Chevron stock since 1991 will collect a little over $100,000 in dividends over the six year stretch.
This does not mean that Chevron shouldn’t be scrutinized during this period in which the price of oil has fallen. Maintaining the $4.28 per share dividend that costs the company $7.7 billion to keep up, in addition to the $25 billion in capital spending, has been a hard juggling act for a company that only generates a little over $8 billion in cash flows with oil at $50 per barrel.
Paying the $7.7 billion dividend has taken a toll on Chevron’s balance sheet. Back in 2013, the financial strength of Chevron was freakish for a business that has to set up and update oil wells and other machinery on over 7 billion barrels of proven reserves–the debt load was only $20 billion. And Chevron was generating $18 billion in cash flows while carrying that $20 billion burden.
Chevron had to ramp up its debt burden from $20 billion to $42 billion over the past three years to keep the dividends to shareholders flowing. Meanwhile, the cash flows are currently only in the $8 billion range with an assumed price of $50 per barrel. The good news for shareholders is that Chevron was able to add all of this debt at a rate of only 3.4%, and it is incredibly long term: only $500 million (yes, with an m) is due within the next five years and the rest is deferred until the 2020s. The low interest rates, and a very robust balance sheet at the start of the oil downturn, has enabled Chevron to borrow without shareholders needing to get smacked in the face with their first ever dividend cut.
The proliferation of dividend websites in the past couple of years, as well as the rise of websites like Seeking Alpha that prominently feature income investing strategies, has made just about everyone interested in investing aware of the fact that dividend growth stocks are a great place to park long-term capital. But still, because this fact gets repeated so often, it can be easy to put a mental block about it–especially during a bull market in which other strategies make people get richer faster and downside protection is mostly an afterthought.
That’s a shame because *protecting capital* can perfectly coexist with a strategy aimed at *building wealth.* If there are six or seven dozen global businesses that not only protect you from steep losses if you have a bit of patience during cyclical downturns while also building sizable wealth during the ordinary and good times, why not spend your life dedicating your surplus resources to the acquisition of an ownership stake in those businesses? Chevron is one of those stocks–see the 1% gain over the past 2.5 years with dividends reinvested while oil has fallen over 50% for a mini real-world example of the concept in action.
Originally posted 2016-06-08 02:29:18.