Chances are your parents or grandparents owned a healthy dose of utility stocks like Consolidated Edison (ticker: ED) and touted the virtues of generous dividends and steady but not stunning growth.
But today’s investor lives in an age of wide diversification through mutual funds and exchange-traded funds. If you have a broad portfolio, utilities are almost certainly in there, but diluted with all sorts of other holdings. Of course, you could buy individual stocks, or a fund that specializes in this sector.
With bank savings and Treasurys offering only the skimpiest income, some fat dividends would be welcome, and the average utility stock yields more than 3.5 percent — not much in your grandparents’ time but pretty good today.
[See: 20 Awesome Dividend Stocks for Guaranteed Income.]
So, are utilities, mostly providers of electricity, gas or water, still the steady but unsexy dividend churners they used to be? What role should they have in a modern portfolio?
As with most investing matters, views are mixed, even though utilities have had a good run this year.
Jeff Bishop, a trader who advises users of the trading site Top Stock Picks, thinks electric utilities are a good bet.
“Utility stocks make money from selling power to commercial and retail users, and that is a trend that is not going away anytime soon,” he says. “Total net (electricity) generation was up 2.9 percent year over year. This is going to continue to be higher than U.S. GDP growth for the foreseeable future, in my opinion.”
Morningstar, the market-data firm, reported early this month that “utilities continue to hold their place as the best-performing sector in 2016, up 18 percent through mid-September,” adding that “U.S. utilities’ dividends, credit metrics, and growth outlook are by and large incredibly strong.”
Average dividend yield of U.S. utilities is 3.6 percent, 2 percentage points above the 10-year Treasury yield, and Morningstar expects those dividends to grow at a healthy 5 percent a year.
“This combination of dividend yield plus growth portends excellent cash returns for income investors relative to fixed-income options,” Morningstar says.
To be fair, Morningstar notes that utilities shares do seem a tad pricey, and warns that regulators are under pressure to cut some key revenue sources, such as electricity rates.
Nonetheless, Travis Miller, Morningstar’s director of utilities equity research, says investors inclined to individual stocks might take a look at Dominion Resources (D), yielding 3.76 percent, Southern Co. (SO) at 4.35 percent and Duke Energy Corp. (DUK) at 4.25 percent. All three, he says in a research report, are well positioned to thrive despite tougher environmental regulations.
Taking the other view, Scott Wren, senior global equity strategist for Wells Fargo Investment Institute, thinks the sector is too expensive. Like other defensive sectors, such as telecom services and consumer staples, utilities will lag as the economy picks up and favors cyclical stocks, he says.
“Utilities are still safe and reliable income producers but we continue to recommend an underweight position in utilities,” he says. “Our work shows this sector underperforming the S&P 500 even when including an attractive dividend yield.”
[See: 7 Dividend Stocks to Buy That Pay More Each Year.]
He adds: “Since the March 2009 lows in the S&P 500, utilities have underperformed that index by nearly 30 percent.”
Utilities, he says, are not a good choice for investors who want to bet on a strengthening economy and growing earnings, as utilities “are not sensitive to the ebb and flow of the economy.”
The ideal utilities investors are those “in need of income, cautious on the economic outlook and not oriented toward outperforming the S&P 500 index,” he says.
Investors not inclined toward individual issues have plenty of utilities-oriented funds to choose from — Morningstar lists about 100 with “utilities” in the name.
“For most individual investors, I believed mutual funds or ETFs are a much more efficient way to get exposure to a stock sector,” says Bob Johnson, president of the American College of Financial Services in Bryn Mawr, Pennsylvania. “Funds or ETFs have the benefit of diversification that is difficult for an individual to replicate. Having funds or ETFs eliminates the idiosyncratic risk of holding individual investments.”
Bishop likes Utilities Select Sector SPDR ETF (XLU), an exchange-traded fund containing the largest utilities, with the three stocks on Morningstar’s list among its largest holdings. It yields 3.27 percent.
“We have seen slow, consistent growth in XLU earnings over time, (with) 5 percent annual forecast growth over the next five years, and I expect that would continue to be the case,” Bishop says.
The fund is up nearly 16 percent this year, with returns averaging 7 percent over the past decade.
Since the experts are more optimistic about dividends than price gains, the income-oriented investor hoping for yields around the 3.6 percent category average might focus on funds with low expense ratios like XLU’s 0.14 percent or $14 for every $10,000 invested.
Vanguard Utilities ETF ( VPU), yielding 3.09 percent, for example, carries an expense ratio of just 0.1 percent. At the other extreme are managed funds like Rydex Utilities C ( RYCUX), yielding just 1.7 percent and charging a 1 percent front-end load and 2.35 percent in annual expenses.
[See: 9 Blue-Chip Powerhouse ETFs to Buy.]
If dividends are all you count on, you don’t want to chew them away with big fees.
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Utilities Are a Good Option for Today’s Portfolios originally appeared on usnews.com
