I'll cut to the chase. Devon Energy (DVN -0.48%) is an attractive stock, but only for a specific type of investor. Here's what you need to know about the company's prospects in 2025 and whether the stock suits your portfolio.

Devon Energy makes progress

In a nutshell, Devon Energy is an excellent stock for investors who are optimistic about oil and gas over the long term. The company's recent results showed good operational progress, notably integrating its Grayson Mill acquisition. Total company oil and gas production hit 848,000 barrels of oil equivalent per day (BOE/D) in the fourth quarter, compared to a prior estimate of 811,000 BOE/D to 830,000 BOE/D.

The outperformance was driven by better-than-expected well productivity in its Eagle Ford assets and a contribution of 117,000 BOE/D from the Grayson Mill acquisition compared to a prior estimate of 110,000 BOE/D.

The impressive result encouraged management to raise its guidance for 2025 by 2% to a new range of 805,000 BOE/D to 825,000 BOE/D, which management estimates will result in free cash flow (FCF) of more than $3 billion assuming a price of oil of $70 per barrel. Given that its market cap is only about $24.4 billion, it implies FCF is equivalent to 12.3% of its market cap.

That's an excellent valuation for investors. Looking ahead, management believes integrating Grayson Mill with its existing assets in the Bakken region will result in additional cost savings. Further, continuing investment in multizone projects in its core Permian region assets should increase operational efficiency.

The valuation is attractive, and management successfully integrated an acquisition and improved operating efficiency. For energy-focused investors, there's a lot to like.

Image source: Getty Images.

What about Devon Energy's dividend?

It's time to address the dividend elephant in the room, illustrated by the following chart. The company's capital allocation plan calls for using 30% of FCF to improve its balance sheet and the remaining 70% to return cash to investors through share buybacks and dividends. However, the variable dividend component disappeared in the third quarter of 2024, and management's press release referred to "delivering value to shareholders through a sustainable, annually growing fixed dividend."

The fixed dividend was increased, but if Devon does not pay a variable dividend in 2025, its dividend yield will be just 2.6% based on the current price. If dividend income is essential to you, then Devon Energy might not be the right stock for you.

Data source: Devon Energy. Chart by author.

Devon Energy's capital return policy

That said, there's a reason why Devon Energy's dividend payment isn't at the levels of previous years, and it doesn't just come down to a relatively lower price of oil compared to 2022. As we've just seen, its FCF could be equivalent to 12.3% of its current market cap, so there appears to be ample financial flexibility to pay an increased variable dividend.

Instead, management plans to spend $800 million to $1.2 billion of the potential $3 billion in FCF on share buybacks. The fixed dividend will cost roughly $620 million in 2025 and about $900 million (30% of FCF) earmarked to improve the balance sheet.

Assuming $1.2 billion in buybacks, $620 million in dividends, and $900 million to improve the balance sheet (pay back debt and increase cash), it totals $2.72 billion, implying there's flexibility from the potential $3 billion. Analysts asked about the subject on the earnings call with CFO Jeffrey Ritenour, noting . that Devon has $1.5 billion of its debt of $8.9 billion that will mature in 2025 and 2026, meaning "we'll have ample opportunities to pay down debt." Ritenour went on to say, "We think there's upside on our ability on the cash returns to shareholders, specifically on the share repurchases."

Overall, it seems highly likely that Devon will focus on debt repayment and share repurchases rather than a variable dividend in 2025.

Image source: Getty Images.

A stock to buy

There's nothing wrong with Devon's capital allocation strategy. On the contrary, it will reduce the share count and result in reduced interest payments in the future. This implies, ceteris paribus, more cash flow per share for investors in the future and a better opportunity to return cash to investors. However, if you are only looking at Devon for dividends over the next year or two, there are better stocks for that purpose.