Value Line is regarded as the best independent research available. More than just recommendations, Value Line provides the rationale behind its picks for greater understanding.
- Don D., California
Investing in Electric Utility Stocks
Electric utility stocks are known for their high dividend yields and their defensive characteristics. As of August 17, 2010, the average yield on electric utility equities was 4.5%. This was more than twice the median of all dividend-paying stocks under Value Line coverage. The average (unweighted) Safety rank of the 54 stocks in the Electric Utility Industry was 2.4. This is closer to 2 (Above Average) than 3 (Average), and indicates that the stocks in this industry, as a whole, are less risky than the average equity under our coverage. Similarly, a portfolio of utility stocks will likely exhibit below-average market volatility, given that each issue’s Beta is below 1.00 (significantly lower than 1.00, in many cases).
With the Federal Reserve keeping interest rates historically low, and reluctant to raise them anytime soon, investors seeking income don’t have a lot of appealing options. Interest rates on savings accounts and money-market funds are minuscule. Rates on certificates of deposit aren’t much higher. So, some investors are turning to electric utility equities. As of August 17, 2010, the Value Line Utility Average (which includes other kinds of utilities in addition to electric companies) was up 2.7% year to date. That’s not much, but it compares favorably with the Value Line Composite Average, which was virtually unchanged over that span. When dividends are factored in, the relative advantage of utility stocks so far this year is even greater.
Electric utility stocks are less risky than most other equities, but they are not risk-free investments. The fact that the Value Line Utility Average declined “only” about half as much as the Value Line Composite Average fell in 2008 was hardly much consolation to utility investors that year. Even so, income-oriented investors who are willing to assume some market risk ought to consider electric utility equities.
With the exception of El Paso Electric (EE), which pays no dividend, the yields of electric utility stocks as of August 17, 2010 ranged from 2.3% for ITC Holdings (ITC) to 6.4% for UIL Holdings (UIL) and Empire District Electric (EDE). Utility stocks with a high yield are not necessarily more attractive than those with a low yield, just as stocks with low price/earnings ratios aren’t necessarily better than those with high p/e ratios. The yield is a measure of valuation. A high yield merely indicates that the stock is cheaper, not better.
Why does one utility stock have a different yield than another? The valuation is influenced by factors such as dividend growth potential, financial strength, regulatory risk, and the prospects of nonutility businesses (if any). A yield that is significantly above average usually indicates that there is at least one reason for concern. For instance, Empire District and UIL Holdings haven’t raised their dividends for many years. By contrast, ITC Holdings has a low yield because its earnings are growing at a much faster pace than most other utilities. Wisconsin Energy (WEC), which was yielding 2.9% as of August 17, 2010, has a low yield (by utility standards) because its dividend growth prospects are far superior to those of most other electric companies. We refer investors to the individual stock pages for our opinions on individual utility stocks. In general, however, we are wary of utility equities that are trading within our 3- to 5-year Target Price Range. Even those that have a respectable yield often have poor long-term total return potential.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.