How do you measure your income and its quality?

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How do you measure your income and its quality?

This year the energy sector is the best performer in the stock market as oil and natural gas prices have soared.

Several energy companies that pay low dividends can make attractive to income-seeking investors at a time of low interest rates.

How do you measure your income and its quality?

For energy stocks, a simple test can be applied.

First let s look at the movement of crude oil prices over the past 10 years, based on continuous forward-month contract prices for West Texas Intermediate crude oil WTI CL 00, tracked by FactSet:

WTI began a long decline from a 10 year intraday high of $112.24 a barrel on August 28, 2013, although the painful drop was began the following year.

The breakdown of demand during the initial phases of the COVID - 19 pandemic was so extreme that the forward-month contract price dropped below zero momentarily in April 2020. Even with WTI s price rising 68% this year to $82.32 a barrel and feeding a bounce in energy-stock prices, there is a long way to go before it returns to its 10 -year high.

And that points to the simple quality test: Which energy companies with attractive dividend yields were able to avoid cutting their payouts through oil s brutal decline that reversed last year?

There are 107 oil stocks in the Russell 3000 Index RUA, which is itself representing about 98% of the U.S. stock market by capitalization (CME) Among those stocks, 15 have dividend yields higher than 4%. That is a good yield in this market, where 10 - year U.S. Treasury notes TMUBMUSD 10 Y yield only 1.54%.

Among those 15 companies, six have raised the dividends over the past 10 years, while four ONEOK Inc. OKE, Exxon Mobil Corp. XOM, Valero Energy Corp. VLO and Chevron Corp. CVX, not only avoided cutting their dividends, they also cut them over the years. A fifth, Phillips 66 PSX, raised it in 2012 and initiated it from there. Four more companies initiated dividends in 2019 or 2021.

The following table includes all 15 stocks, marked by yield, with the five that didn't cut dividends during or after the long oil price slide sorted in bold.

The table also includes estimates free cash flow yields for 2022, based on consensus estimates of free cash flow per share among analysts polled by FactSet, if available. For several of the smaller companies on the list, this information isn't available.

A company's remaining cash flow is its cash flow after capital expenditures. It is money that can be used for dividend increases, stock buybacks, business expansion or other corporate purposes. An estimate of a company's current cash flow yield by dividing the 2022 FCF estimate by free share price. Comparing FCF yield to the current yield provides plenty of headroom for the five highlighted stocks, providing some comfort to investors that the dividends will continue to flow and maybe be increased.

To this screen, Charles Schwab Asset Management Chief Investment Officer Bill McMahon said he preferred to avoid high yielding dividend stocks because high yields and low share prices would indicate trouble ahead. A higher yield combined with a moderate FCF yield may point to better growth characteristics for a company, he said.

McMahon also said during the same interview that it would be good to balance a portfolio of stocks with higher dividend yields, well supported by FCF with moderate stocks for income. The five companies highlighted above fit the bill, especially with so much headroom for dividend increases.

He also said that his team at Schwab Asset Management remained overweight energy stocks and that he expected the demand-side of the energy equation to continue to rise. Don t miss: These fund managers have found the key to winning quality stocks — and these are the ones they own.