Juice Up Your Dividends With Electric Utilities

The last time I wrote about regulated electric utilities, in November 2011, I assailed Wall Street for habitually dissing the stocks. Granted, utilities didn’t excel in 2012, but their weakness owed mainly to the fear that Congress might enact a massive tax increase on dividends. That didn’t happen, though, and the sector has been on a tear since late November 2012. Longer-term results are also impressive. Tee up multiyear price charts of your favorite power companies. If you exclude such troubled utilities as Exelon and Public Service Enterprise Group, and ignore the blips caused by Hurricane Sandy for otherwise solid performers such as Consolidated Edison, you’ll see terrific trajectories.

Traditional utilities are critical investments for income-seeking investors, and I’m deliberately saying this at the start of the summer storm season. Somewhere, a utility (or several of them) will suffer hundreds of millions of dollars in wind and water damage. A stock will sink 10%, and a company will come under pressure to cut or suspend dividends, no matter how quickly it restores service. Regulators now incorporate disaster preparedness and customer service into their rate decisions. That means they can require utilities to spend additional revenues from higher rates on everyone and everything except investors.

Perhaps that’s as it should be. But because regulatory matters are subjective, many Wall Street analysts say it’s difficult to determine whether a utility will earn its allowable profit margin. So for many, their attitude toward the stocks they follow tends to be negative, and their reports tend to include a disproportionate percentage (by Wall Street standards) of “sell,” “reduce” and “underweight” recommendations.

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But if you want a 4% dividend yield, a little growth and a minimal number of shocks, you will find that electric utilities shine brightly. For starters, everyone needs power. With the economy growing, demand for electricity should continue to rise, albeit modestly. Coal and natural gas, which are used to generate electricity, are cheap; disruptive technological developments, such as a vast expansion of off-the-grid solar power, are many years off. Dividend growth may be slowing -- payouts are likely to rise less than 5% this year, after climbing 6.6% in 2012 -- but widespread cuts and omissions are in the past. And although mergers create little value in some industries, such hookups in the electric sector can effectively cut redundant costs.

Back to basics. Ten years ago, utility exe­cutives thought it was essential to enter unregulated and nontraditional businesses, such as power trading. But the adventurers wisely retreated after Enron collapsed and Dynegy found itself in Chapter 11. (Dynegy emerged from reorganization last October, but Dynegy’s pre-bankruptcy shareholders got only 1% of the new company.) The resulting back-to-basics movement is a winner for risk-averse utility shareholders, who prefer dividends, safety and quality to pizazz.

If you’re not interested in picking stocks, look no further than Vanguard Utilities ETF (symbol VPU, $88, 3.4%). The exchange-traded fund holds 78 stocks, with 86% of its assets in pure electrics and diversified utilities. And it charges just 0.14% of assets per year (prices are as of May 2).

There are dozens of worthy choices among individual issues. Look for those that sell at or below the industry average of 1.7 times book value (assets minus lia­bilities). Our exemplar is American Electric Power (AEP, $51, 3.7%), which sells for 1.6 times book value. The company serves five million customers in 11 states and says 95% of its earnings are from regulated power sales. Duke Energy (DUK, $75, 4.1%) is also in fine shape. It sells for 1.3 times book value, and 90% of its earnings are regulated.

Jeff Kosnett is a senior editor at Kiplinger’s Personal Finance.