The 2 Best High-Yield Energy Stocks in Vanguard High Dividend Yield ETF

Exchange-traded funds (ETFs) like Vanguard High Dividend Yield ETF (NYSEMKT: VYM) provide a simple way to invest broadly in a key theme -- in this case, stocks with a high dividend yield -- to generate passive income.

ETFs can also be great tools for finding top stock ideas for those seeking to build their own diversified portfolio. With both approaches in mind, here's a closer look at the Vanguard High Dividend ETF and two top energy dividend stocks from that fund, Chevron (NYSE: CVX) and ExxonMobil (NYSE: XOM), that could supply investors with a higher-octane stream of dividend income.

The Vanguard High Dividend Yield ETF is like an S&P 500 for dividend stocks

Reuben Gregg Brewer (Vanguard High Dividend Yield ETF): When it comes to investing, the benchmark most often used to represent the "market" is the S&P 500 index. It is designed to broadly represent the economy, so this makes sense and makes an S&P 500-based ETF a good pick for passive investors. However, if you are a dividend investor, Vanguard High Dividend Yield ETF could offer a similar solution with an income twist.

For starters, the Vanguard High Dividend Yield ETF looks at all dividend-paying companies, with the exception of real estate investment trusts (REITs). Thus, it offers fairly broad-based exposure to dividend stocks.

Second, it creates its portfolio by lining up the stocks by yield, selecting the highest-yielding 50% of the list. Thus, it favors high-yield stocks.

Finally, the list of holdings ends up being very large, currently over 500 companies. So, it has about as much stock diversification as the S&P 500, with the portfolio fairly well spread across different industry sectors. If you are a passive investor with a dividend focus, it's a decent one-and-done solution.

That said, there's one problem. With so many holdings, Vanguard High Dividend Yield ETF's dividend yield is 2.8%. That's much better than the S&P 500's 1.2%, but you can easily do better if you cherry-pick from the ETF's holdings. By being selective, you won't be taking a blanket approach, accepting any old dividend-paying stock. You can choose the best companies with the best yields. So, for more active investors, this ETF could be a good launch pad for picking stocks.

A durable dividend stock

Neha Chamaria (ExxonMobil): ExxonMobil is among the top five largest holdings in the Vanguard High Dividend Yield ETF. It is also one of the best energy dividend stocks you can own, currently yielding 3.2%.

ExxonMobil increased its dividend per share for the 41st consecutive year in 2023 and is expected to announce its next hike in the coming weeks. Its dividend track record speaks volumes about the company's resilience despite the volatility in oil and gas prices.

During its latest annual shareholder meeting, ExxonMobil reiterated that it remains committed to paying a dividend, even during low commodity price cycles, while ensuring the dividends it pays during an oil boom are sustainable during price lows. This balanced and prudent approach explains why the oil and gas giant could pay bigger dividends to its shareholders, even in years of oil turmoil, like in 2020, when peers cut dividends.

Even before ExxonMobil acquired Pioneer Natural Resources in a massive $64.5 billion deal in May, it said it could double its earnings and cash flows by 2027 versus 2019 at a Brent crude oil price of $60 per barrel. ExxonMobil expects its earnings and cash flows to grow more quickly after the acquisition, which should mean even bigger dividends and share repurchases.

A high-octane income stream

Matt DiLallo (Chevron): Chevron currently ranks as the 12th-largest holding in the Vanguard High Dividend ETF (1.4% allocation). The oil giant is a leader in paying dividends.

The energy company has increased its dividend for 37 straight years, the second-longest streak in the energy sector, behind Exxon. Meanwhile, it has grown its dividend faster than the S&P 500 over the last five years, including more than doubling the rate of Exxon. Its most recent increase was 8%, an acceleration from the more than 5% annual growth it has delivered in recent years.

Chevron should have plenty of fuel to continue increasing its high-yielding dividend (currently 4.3%). The oil giant expects to grow its cash flow at a more than 10% annual rate through 2027, assuming an average price for Brent oil (the global benchmark) of around $60 a barrel (Brent is currently at around $75 a barrel).

Meanwhile, at $70 a barrel, Chevron can produce enough excess free cash flow to repurchase shares at the upper end of its $10 billion-$20 billion annual target range (and retire about 6% of its outstanding shares each year). With its cash flow growing and its share count falling, Chevron's dividend per share should continue rising.

The company's cash flow could grow even faster if it can complete its needle-moving acquisition of Hess. That deal would more than double its free cash flow by 2027, assuming $70 oil. Meanwhile, there's ample downside protection. Thanks to its low operating costs and fortress balance sheet, Chevron can fund its capital program, a growing dividend, and repurchase shares at the low end of its target range (retiring about 3% per year) at $50 Brent.

With a high yield and remarkable growth record that should continue, Chevron is a great income stock to buy on its own or as part of the package of high-yielding stocks in the Vanguard High Dividend Yield ETF.

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Matt DiLallo has positions in Chevron. Neha Chamaria has no position in any of the stocks mentioned. Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chevron and Vanguard Whitehall Funds-Vanguard High Dividend Yield ETF. The Motley Fool has a disclosure policy.