To The Moon

$Chevron(CVX)$

Why Investors Like Chevron

One of the key reasons investors are drawn to Chevron is its strong dividend yield of 4.43%, supported by a history of consistent payouts and solid free cash flow generation. With a market capitalization of $264 billion and a price-to-earnings (P/E) ratio of 16.12 (which is significantly lower than the market average of around 30), Chevron presents an intriguing opportunity for dividend and value investors alike.

According to analysts, the stock has a price target of $175 per share, indicating potential upside from current levels. The company's dividend payout ratio of 70% suggests a relatively safe and sustainable dividend, despite fluctuations in free cash flow payout ratios.

Managing Volatility with Dividend Stocks

If you're concerned about recent stock market volatility and have a portfolio heavily concentrated in growth stocks, adding a dividend stock like Chevron could be a strategic way to reduce overall risk. In this video, I'll evaluate Chevron stock to determine whether it's an excellent investment for dividend-focused investors seeking passive income or growth investors looking to diversify and manage risk.

I'll analyze the company's revenue growth history, profitability, cash flow, and returns on investor capital. Then, I'll assess its valuation using a discounted cash flow model, as well as forward price-to-earnings and price-to-free-cash-flow ratios. Ultimately, I'll answer whether this dividend stock—currently yielding 4.15%—is a buy at today's prices.

The Volatility of Energy Stocks

When considering Chevron and other energy companies, it's important to note that revenue growth can be volatile, influenced by factors such as oil prices, demand, and macroeconomic trends. In the long term, the current U.S. administration has adopted a more favorable stance toward energy companies and is less aggressive in promoting electric vehicles. While this benefits companies like Chevron, investors shouldn't place too much emphasis on political policies when making investment decisions.

The Risks of Relying on Politics

Political landscapes shift frequently, with policies often being reversed by subsequent administrations. For example, just as Joe Biden sought to undo many of Donald Trump's policies upon taking office, a future administration could reverse Biden’s policies as well. This cycle of political change underscores why it's risky to base investments on government support alone—something that has posed challenges for electric vehicle investors, who relied heavily on government incentives to propel the industry forward.

Chevron's Dividend Appeal

One of the key factors that passive income and dividend stock investors consider is dividend yield. Chevron currently offers a dividend yield of 4.15%, making it an attractive option for income-focused investors.

Operating Profit Margins and Volatility

Chevron’s most recent operating profit margin stood at 99.78%. However, like other oil companies, its margins can be volatile due to fluctuations in oil prices. Ideally, investors look for a trend of higher highs and higher lows over time. In Chevron’s case, the most recent expansion saw operating margins peak near 15%, compared to the previous peak of around 10%. Currently, margins are declining as oil prices fall from their 2022 highs.

Oil Prices and Political Influence

The overall trend for oil prices appears to be downward. The current Republican administration, under Donald Trump, is more favorable toward energy production and policies that promote lower oil prices, as opposed to encouraging alternative energy adoption, even if those alternatives come at a higher cost.

Cash Flow Stability Despite Volatility

Chevron’s cash flow from operations, relative to sales, exhibits some volatility but remains more stable than operating profit. This is largely due to significant non-cash expenses, such as depreciation and amortization of physical energy production equipment. Because of this, cash flow from operations is often a more reliable metric for evaluating energy companies like Chevron than operating profit margins.

Return on Investor Capital

Return on investor capital (ROIC) measures how efficiently a company converts investor funds into profits and cash flow. While Chevron returns a significant portion of its earnings to investors through dividends, it also retains earnings for reinvestment. If a company fails to generate strong returns on retained earnings, investors may pressure management to distribute more capital instead of reinvesting.

At its recent peak, Chevron's ROIC reached approximately 20%, though it has since declined to 9.71%. Ideally, ROIC should exceed the company’s weighted average cost of capital (WACC), which for Chevron is around 10%. Historically, Chevron’s ROIC has fluctuated between 10% and negative 8% over the past decade, with extreme lows during the pandemic.

The Impact of OPEC on Oil Prices

Oil prices are often driven by global events, and while they can decline at times, they tend to surge more frequently. The Organization of Petroleum Exporting Countries (OPEC) plays a significant role in stabilizing and maintaining high oil prices by limiting production. This influence helps sustain price levels more effectively than it lowers them, benefiting companies like Chevron.

Chevron's Valuation Overview

Chevron is currently trading at a forward price-to-earnings (PE) ratio of 12.7 and a price-to-free-cash-flow ratio of 19. Based on these metrics, I would categorize it as fairly priced to slightly overvalued, considering the company's revenue growth, cash flow, return on invested capital (ROIC), and cash flow from operations. Ideally, for a company with these fundamentals, I would prefer a lower valuation on a forward PE and price-to-free-cash-flow basis.

Let’s take a look at Chevron’s valuation using the Discounted Free Cash Flow (DCF) Model. This model evaluates stocks by projecting their future free cash flows and discounting them to present value. Currently, the weighted average cost of capital (WACC) is set, and I’ve noticed a discrepancy with the DCF calculation showing a minus $21 per share. There might be an issue with the input values, so let’s adjust and check again.

We are expecting future revenues of $218 billion and $240 billion in the coming years. Let’s compare this with analyst predictions, which estimate revenues of $190 billion to $204 billion (with a bullish case of $204 billion). If we assume Chevron’s revenue declines at the current rate of 1.6%, we can adjust the future cash flows accordingly. After considering the net income margins and average figures from the past few years, we estimate a more realistic share price of $115 based on the DCF method.

For a more optimistic scenario, assuming Chevron’s revenue growth increases at 3.5% annually, the intrinsic value climbs to $177 per share—remarkably close to the analyst target of $175. This makes Chevron appear slightly undervalued under this model.

Discounted Cash Flow Analysis

However, when evaluating Chevron through my discounted cash flow (DCF) valuation model, I arrived at an intrinsic value of $183 per share, compared to its current market price of $158. From this perspective, the stock appears somewhat undervalued. Therefore, while Chevron may seem slightly overvalued based on price-to-free-cash-flow, the DCF model suggests it has some upside potential.

For those interested in a detailed breakdown of my discounted cash flow model, I offer member-exclusive videos explaining all of my DCF valuations. You can join my channel for access to these in-depth analyses.

Benjamin Graham’s Intrinsic Value Formula

Next, let’s use Benjamin Graham’s formula to estimate Chevron’s intrinsic value. This model relies on earnings per share (EPS), P/E ratios, company growth rates, and the bond yield (currently 5.2%). Given Chevron’s expected growth rate of around 9% (according to analysts), this method calculates an intrinsic value of about $134 per share. For Chevron to be considered a buy, it would need to grow at a higher rate of around 12%, so it’s currently fairly valued according to this model.

Is Chevron a Good Dividend Stock to Buy?

Based on these valuation models, Chevron’s stock is fairly valued, with some indicators showing slight undervaluation and others showing slight overvaluation. Its 4% dividend yield remains an attractive feature for income investors, and for those looking for diversification in the energy sector, it presents a solid option.

So, is Chevron an excellent dividend stock to buy at its current price? I would categorize it as fairly valued. While I always prefer to pay a fair price for an outstanding business, Chevron falls into the "good" rather than "excellent" category. Nonetheless, I would rate Chevron as a buy, particularly for investors who do not yet own energy stocks.

Diversification Benefits of Energy Stocks

Energy stocks like Chevron provide valuable diversification benefits. Most people consume a significant amount of energy each month and are naturally exposed to oil price fluctuations. Owning Chevron stock can help offset these fluctuations—if oil prices rise, you'll spend more on fuel, but Chevron's stock price is likely to increase as well. Conversely, if oil prices decline, the stock price might dip, but you'll save money on fuel costs. This natural hedge makes Chevron a useful addition to a diversified portfolio.

Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose.

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