Energy stocks will be hot again in 2023. But now it’s all about dividends

(Bloomberg) — After two consecutive years of big gains, energy stocks could outperform the market again in 2023, but this time it will be higher dividends rather than oil that will spur appetite for the sector.

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In an effort to lure income investors, energy companies have aggressively raised dividends over the past 12 months. Diamondback Energy Inc. increased its payout by 412% in the range, the most of any S&P 500 member. Five of the index’s 10 largest dividend increases come from the energy sector, including APA’s 355% increase Corp., Pioneer Natural Resources Co.’s 276% increase, and Halliburton Co.’s 167% increase.

Those oversized payments will look even more attractive if the US economy slides into a recession next year, which would add to the allure of cash. U.S. real gross domestic product is projected to shrink to just 0.3 percent growth in 2023, down from 1.9 percent in 2022, according to data compiled by Bloomberg.

“In a recession, I want to see money,” Energy Income Partners chief executive James Murchie said, adding that his investment firm was launched during the bursting of the dot-com bubble because investors were looking for “real income and real assets.” He expects the same dynamic to play out in a potential recession in 2023, driving equity positioning in dividend-paying stocks in the energy and utilities sectors.

“We want real assets rather than vaporware in our portfolio,” Murchie said.

Investors will seek total returns rather than just share price gains in 2023, Savita Subramanian, head of equity and quantitative strategy at Bank of America, said in an interview with Bloomberg TV this week. Subramanian was also optimistic about the energy sector, which she said has demonstrated moderation in spending despite rising oil prices.

The total return of the S&P 500 Energy Index so far in 2022 is approaching 63%, which falls to 57% price appreciation and another 6% from yield. In contrast, the broader S&P 500 posted a negative total return of 17%, just slightly better than its 19% price drop thanks to payments from index members.

The group of energy stocks in the US equity benchmark was up about 2% in New York on Wednesday.

Investors tend to rush into dividend-paying stocks in a recession in search of cash as the economy collapses around them and dollars are harder to earn. But investors should look deeper and select companies for free cash flow, rather than dividends, if they are looking for reliable income streams during a recession, said Ivana Delevska of SPEAR Invest.

“That’s the broader key to the market: cash flow generation,” noted the firm’s chief investment officer, adding that his fund likes commodities and industrials stocks targeting 2023 due to their free liquidity profile and why they are cheap. “The reason we like raw materials and industrials in a recession is because a recession is already a given.”

However, investors looking for free cash flow generation typically find great dividend payers. “Most of the companies that have the highest cash flow yield, have the highest dividends,” said Siebert Williams Shank analyst Gabriele Sorbara.

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