Income-seeking investors shouldn’t underestimate the potential for significant capital returns at Devon Energy (DVN -0.49%). The stock’s dividend isn’t quite at the level it’s been in recent years, but neither is its share price. Moreover, the current trailing-dividend yield of 4.5% is nothing to be sniffed at, and there are major reasons to believe its dividend could significantly increase in 2025. Here’s why Devon Energy is an excellent stock for high dividend-yield-focused investors.

An oil and gas stock growing cash flow and dividends

This is an oil and gas exploration and production company, so if you aren’t comfortable with the outlook for energy prices or aren’t looking to include energy exposure in your portfolio, read no further.

That said, many investors are looking for exposure to energy prices or are agnostic about their direction. In that case, Devon’s mix of very high cash-flow generation, strategic acquisition of Grayson Mill Energy’s Williston basin (Bakken) business for $5 billion, and capital-return strategy are compelling reasons to buy the stock.

Devon Energy’s dividend history

The following chart demonstrates how Devon Energy reduced its dividend from 2022. The dividend (a combination of fixed and variable payments) totaled $5.06 in 2022. Based on the current price of $44.65 a share, it would represent a whopping 11.4% dividend yield.

In contrast, the current trailing-dividend payout of $2 a share yields 4.5%.

Data source: Devon Energy presentations. Chart by author.

Still, it’s important not to overemphasize where a stock has been rather than where it might be going. The reality is that oil and gas prices tend to be volatile and will remain so as long as there’s a marketplace. In particular, the decline in the cost of gas negatively impacted Devon Energy’s earnings, cash flow, and, ultimately, its dividend through 2023.

WTI Crude Oil Spot Price data by YCharts.

However, current energy prices and Devon’s stock price support the thesis that its dividend is likely to increase significantly in 2025.

Why Devon Energy is set to make its dividends great again

First, Devon’s free-cash-flow (FCF) yield is very high at the current stock price. Management helpfully gives an outline estimate of its FCF yield at a range of oil prices per barrel in 2024. The forecast used the market cap on Aug.2 when the stock closed the day at $42.79.

Using those estimates and the updated price of Devon stock produces a rough estimate of an FCF yield of 8.6% at a price of $70 a barrel, 10.5% at $80 a barrel, and 12.5% at $90 a barrel.

Image source: Getty Images.

Second, these estimates don’t include the acquisition intended to close in the third quarter of 2024. Devon estimates its full-year production volume will be 677,000 oil-equivalent barrels a day (BOE) to 688,000 BOE in 2024, and the addition of the acquisition will add 100,000 BOE in 2025. That’s an almost 15% addition to production, and management believes it will add 15% to its FCF generation in 2025 too. It will be “accretive to share buyback capabilities and dividend payout.”

Finally, the company’s capital-allocation policy dictates that 70% of its free cash flow (FCF) should be allocated to returning cash through share buybacks, a fixed quarterly dividend (currently $0.22), and a variable dividend.

Given the low stock price, management has prioritized share repurchases in 2024. Devon spent $461 million on share buybacks in the first half, compared to $281 million on the fixed dividend and just $220 million on the variable dividend.

Image source: Getty Images.

Devon Energy’s dividend could increase significantly

Overall, provided energy prices stay stable, Devon’s increased production will translate into significantly improved FCF. By way of example, assuming a price of oil of $70 a barrel in 2024 and the current price, Devon’s FCF yield could be 8.6%. Allocating 70% of FCF toward cash returns, in the form of dividends only, could produce a yield of 6%.

And a 15% increase in FCF in 2025, all things being equal, could mean a 6.9% dividend yield and even more if the price of oil is above $70 in 2025.