The Hottest Dividend Play In A Collapsing Market

Historically, a large part of the appeal of investing in the energy sector has, for many people, been the dividend payouts that the sector offers. Recently though, even that advantage of owning large, multinational oil stocks has been called into question. Oil’s spectacular collapse has led to the assumption that dividends will be cut, so yield hunting has been a dangerous game.

This week, however, some major oil stocks have hit a point where yields are looking too good to pass up and will even remain good if a dividend cut does come. Royal Dutch Shell (RDS/A) is a good example. In the interest of full disclosure, I should say that I bought some RDS/A in my own account on Wednesday when the yield hit sixteen percent.

Here’s my rationale for doing so.

The most obvious thing is that sixteen percent is a massive number when the 10-Year Treasury Note is yielding around one percent. Interest rates around the world are at or near historic lows, and yield is becoming increasingly hard to find. That applies to individual investors, but, more importantly in many ways, it also applies to the big funds and institutions.

Pension funds, for example, need to generate income from a portion of their investments in order to meet their mandated payouts, and one percent from Treasuries just doesn’t cut it. There is an obvious risk to your capital when you buy any energy stock these days, but there comes a point when, providing the company you pick avoids bankruptcy and you don’t suffer a total loss, buying a massive yield with a small percentage of your fund is well worth that risk.

Those small percentages from a few of the big funds soon add up. It may not be enough to cause a complete bounce if oil continues lower, but it will have the effect of limiting the downside somewhat, even in that scenario.

The share price, however, isn’t the point of this trade. It is all about the yield, so the argument against is that the current yield is vulnerable to what would be an understandable cut in the dividend. My reasoning was that even if they cut the dividend in half, I would still get an attractive 8% payout.

History, however, suggests that a 50% dividend cut is not that likely. In the second half of 2008, for example, as crude collapsed from just under $150 per barrel to just over $30, Royal Dutch Shell didn’t just maintain their dividend, they actually continued to raise it. Even when they have felt the need to reduce payments to shareholders in the past, they have done so by less than fifty percent.