If you live in a house or apartment, you already know about the utilities that take a chunk of your paycheck on an ongoing basis — water, sewer, natural gas, trash, electricity, recycling and more.
Regardless of the type of utility you're familiar with on a day-to-day basis, think beyond the water that comes out of your faucet and the electricity that appears with the flick of a switch. You can also invest in renewable energy, including wind turbines and solar panels. Utilities can also come in the form of cable TV, internet and phone services.
If you have a hankering to invest, utilities can offer stable, consistent dividends and less volatility. However, it's important to understand the pros and cons of utilities, including that they often carry expensive infrastructure, are heavily regulated and often carry significant debt loads (which can make them sensitive to interest rate changes). They may also be sensitive during certain economic cycles.
Let's take a look at an overview of utilities stocks and inflation, whether utilities stocks are a good investment, when utilities stocks do well and performance of particular stocks. Finally, we'll walk through how to invest in utilities stocks.
Utilities Stocks and Inflation
When prices rise, the value of the dollar declines. Some sectors are more hardwearing during market downturns. In contrast to sectors like technology, you may automatically believe that utilities tend to perform well during economic downturns because they offer services necessary for day-to-day living. Your initial thinking may be that the steady income stream from utilities aren't too affected by changes in the economy — people still pay their gas bill, providing an inflation shelter.
Ultimately, during a downed economic cycle, utilities stocks usually don't tumble quite as far as other sectors. However, you might face some dividend risks. Utilities that face rising costs or interest rates may slash their dividends to fix their balance sheets. On the flip side, if the economy is shaping up for a blast off and you want to pursue higher-yielding stocks, utilities may not be your best bet. (This is when tech stocks may lock up a more lucrative option.)
Are Utilities Stocks a Good Investment?
The most important consideration is to calibrate your expectations with your goals. Utilities stocks have unique capabilities, including unique drawbacks and benefits.
Let's take a look at a few considerations to note prior to investing in utilities stocks:
- Regulation: One of the most unique aspects of utilities is the sector's regulated, controlled environment. Many utilities are regulated by state utility commissions, giving them fewer competitors and more predictable cash flows and profits.
- Fixed revenues: Fixed revenues opens you up to risk, particularly when commodities like oil rise. The government orders how much these companies can charge customers, which can equate to a lower earning potential. On the flip side, investors in utility stocks are largely protected from shrinking profit margins.
- Infrastructure cost: High-cost infrastructure is one of the realities of utilities stocks. Utilities companies do better in a lower interest rate environment in large part because of the high costs of its basic physical and organizational structure and facility makeup.
- Debt: Utilities generally carry a lot of debt because of their capital structures and high-cost infrastructure. However, they often have a high credit rating, which usually means they have a good chance of repaying their debts. As debt levels increase, however, credit quality decreases.
- Shifting weather trends: As more natural disasters cover the United States, utility companies find themselves in the center of a firestorm of repairs due to tornadoes, floods and numerous other types of adverse weather conditions.
- Dividends: Utility companies can offer regular dividend increases. Utilities that charge their customers may increase dividends at a faster rate than during low inflation periods.
- Buy-and-hold benefits: Long-term holdings can mean that you'll benefit from generating consistent income due to low volatility and stable dividends, which can also be beneficial during times of economic stagnation.
It's important to consider all the factors involved in purchasing utilities stocks, including the pros and cons that make these types of stocks unique.
When Do Utility Stocks Do Well?
Economic headwinds can urge investors to move toward utilities stocks as a defensive play. Utility dividend stocks can do well during times of inflation, particularly if regulators allow firms to charge more and transfer a portion of their operating costs to consumers.
Always in demand due to their essential services, utilities stocks might show risk during downed economic cycles. At the same time, in most cases, they'll be less risky than the overall stock market.
Whenever interest rates climb, stock prices drop, which can affect utility companies. They're also vulnerable to policy shifts and due to regulation.
During this past year, the utility stock sector was over $1.5 trillion. Earnings for companies in the utilities industry have grown 15% per year over the last three years. Individually, revenues for these companies have grown 8.1% per year, which means sales and profits had been increasing for those who planted utilities in their portfolios.
Top Utilities Stocks List
Let's take a look at several utilities companies, private, for-profit companies you may want to include in your portfolio.
NextEra Energy Inc.
NextEra Energy Inc. (NYSE: NEE) distributes electric power to retail and wholesale customers in North America through wind, solar, nuclear, coal and natural gas facilities through long-term contracted assets like clean energy solutions. It offers:
- Renewable generation facilities
- Battery storage projects
- Electric transmission facilities
- Energy commodities
- Wholesale energy markets
The company had approximately 28,564 megawatts of net generating capacity — 77,000 circuit miles of transmission and distribution lines; and 696 substations. It serves approximately 11 million people through approximately 5.7 million customer accounts in the east and lower west coasts of Florida.
Duke Energy Corporation
Duke Energy Corporation (NYSE: DUK), an energy company headquartered in Charlotte, North Carolina, uses coal, hydroelectric, natural gas, oil, renewable generation and nuclear fuel to generate electricity in the Carolinas, Florida and the Midwest. It also wholesales electricity to the following:
- Municipalities
- Electric cooperative utilities
- Load-serving entities
The company owns approximately 50,259 megawatts of generation capacity and distributes natural gas to residential, commercial, industrial and power generation natural gas customers. The company operates and invests in pipeline transmission and natural gas storage facilities and serves 1.6 million customers.
The company's wind and solar renewable generation projects also include renewable energy and energy storage services for utilities, electric cooperatives, municipalities and corporate customers.
The Southern Company
The Southern Company (NYSE: SO), headquartered in Atlanta, develops, constructs, acquires, owns, and manages power generation assets, including renewable energy projects and electricity sales in the wholesale market across Illinois, Georgia, Virginia and Tennessee. It also provides and offers the following:
- Gas marketing services
- Wholesale gas services
- Gas pipeline investment operations
- Hydroelectric generating stations
- Fossil fuel generating stations
- Nuclear generating stations
- Combined cycle/cogeneration stations
- Solar facilities
- Wind facilities
- Fuel cell facilities
- Battery storage facilities
- Natural gas pipelines
- Storage facilities
The company serves over eight million electric and gas utility customers.
How to Invest in Utility Stocks
How should you approach investing in utility stocks? Let's take a look at a few key steps you can take to invest in utility stocks.
Step 1: Analyze metrics.
Analyzing all the aspects of a particular stock can help you choose the right companies for your particular needs. For example, it's a great idea to take a good look at dividend yield, dividend payout ratio, earnings per share and price-to-earnings ratio:
- Dividend yield: Many utilities stocks pay dividends. Therefore, it's a good idea to calculate the dividend yield, which is the share price a company shares with investors in the form of dividends. The dividend share price takes the dividend per share by the current share price. Let's say a company offers $2 in dividends per year at a cost of $60 per share. The dividend yield is 3%. Watch out for sky-high dividends, which can signal a red flag.
- Dividend payout ratio: The percentage of a company's earnings paid out as dividends is the dividend payout ratio. The lower the payout ratio, the more sustainable a company's dividend. In other words, it's more likely that the company will continue to pay out the dividend. If a company earns $1 million and pays out $50,000 in dividends, the payout ratio would be $50,000 / $1 million = 5%.
- Earnings per share (EPS): EPS analyzes the number of outstanding shares of stock a company has. You can figure it out by determining a company's quarterly or annual net income and dividing that number by the number of outstanding shares of stock it owns.
- Price-to-earnings (P/E) ratio: The price-to-earnings (P/E) ratio helps determine whether a stock is fairly valued. Divide a company's share price by its earnings per share to find its P/E ratio.
Other metrics can help you decide whether you've found the right utilities stock. In addition to price-to-earnings ratio, you can also look at debt-to-equity ratio (a company’s total liabilities to its shareholder equity), free cash flow (the cash flow available for a company to repay creditors or put dividends and interest toward investors) and PEG ratio (a company's P/E ratio divided by the growth rate of its earnings for a specified time period).
Step 2: Open a brokerage account.
If you don't already have a brokerage account, choose the right type of brokerage for your particular needs and set up your account. If you feel you need more hand-holding with your investments, consider choosing a human financial advisor. On the other hand, if you want to manage everything on your own through a robo-advisor, it'll eliminate the need for human interaction.
Before you decide on the right investor for your specific needs, take a look at the costs and fees involved, the platform the brokerage uses and other factors that will help you invest the way you want.
Step 3: Purchase shares and consider reinvesting.
Next, choose the number of shares you want to purchase and buy. Again, make sure that you choose the right investments that meet your goals and timeline for investment. Also consider aiming for diversification, which means you spread out the number of investments you have as well as the type of investments you invest in. Consider reinvesting on a regular basis, such as on a monthly basis, in order to maximize your investment potential.
Utility Stock ETFs
If you're looking for automatic diversification, you may want to consider an exchange-traded fund (ETF). An ETF works like a mutual fund (a pooled investment) but can be traded at any point during the trading day, like a stock. Take a look at the following utilities ETFs:
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