Utilities: Invest Or Avoid?

Investing in utility stocks is a risk reduction tactic that can help stabilise your dividend income. Utility companies are part of a regulated industry and often have fewer competitors, which makes them a safe investment.

Utility stocks are less volatile and more dependable, especially during difficult times. They are also less susceptible to economic downturns because they provide essential services like heat, water, and electricity.

However, utility stocks may not offer huge growth opportunities. They are also highly regulated, which can be a double-edged sword. While regulations provide utilities with monopolistic characteristics and reduce the threat of competition, they also increase the cost of doing business and lower earnings potential.

Overall, utility stocks can be a good investment for those seeking stable and consistent dividend income, but they may not be the best choice for those seeking high growth potential.

The benefits of investing in utility stocks

Utility stocks are an appealing choice for investors due to their stability and reliable dividends. Here are some benefits of investing in utility stocks:

Steady Income and Reduced Volatility

Utility companies provide essential services such as water, electricity, and natural gas, which ensures a steady demand and stable investment. They are considered low-risk investments compared to other stocks because they are regulated entities with predictable profits and expenditures. As a result, they tend to provide consistent dividend payouts and stable performance.

Defensive Investments

Utility stocks are often considered defensive investments, meaning they hold up better during economic downturns. Demand for utilities remains relatively constant, even in deep recessions, making them resistant to economic cycles. This makes them attractive to retirees, conservative investors, and those seeking income-generating investments.

High Dividend Yields

Utility stocks tend to offer higher dividend yields compared to other sectors and fixed-income assets. This is because utility companies operate in stable and predictable businesses, allowing them to pay out a high percentage of their earnings as dividends. The dividends from utility stocks also receive preferred tax treatment, further enhancing their appeal to investors.

Safe and Stable Investments

The essential nature of utility services means there will always be a demand for them. Additionally, government regulations and the high capital requirements create barriers to entry for potential competitors. These factors contribute to the stability and safety of utility stocks, making them less prone to market volatility.

Diversification and Safe Haven

Investing in utility stocks can help diversify an investment portfolio. They can act as a safe haven during economic downturns and bear markets, as investors tend to sell off higher-risk investments first. Utility stocks provide essential services, making them a good option for reducing volatility and enhancing portfolio stability.

The drawbacks of investing in utility stocks

Utility stocks are considered a safe investment due to their stable nature and consistent dividends. However, there are several drawbacks to investing in utility stocks that potential investors should be aware of.

Firstly, utility stocks offer low growth potential compared to other sectors like tech stocks. The companies in this sector are slow to respond to market changes and are highly regulated, often prohibiting them from adjusting their prices significantly. This lack of pricing flexibility can hinder their ability to increase revenues and, consequently, their stock price appreciation.

Secondly, utility companies face changing regulatory costs and challenges as they transition to renewable and zero-emissions energy sources. These regulations can increase their operating costs and impact their earnings potential. Additionally, the heavy regulation of the industry can be a double-edged sword, providing monopolistic characteristics in certain regions but also restricting their growth opportunities.

Thirdly, while utility stocks are considered low-risk investments, they are still subject to market risks and can lose value. For example, utility stocks experienced significant losses during the two major market downturns in the past decade, underscoring their vulnerability to broader economic trends.

Moreover, utility stocks may not provide opportunities for significant short-term growth due to their stable nature. Their slow and steady performance may not appeal to investors seeking rapid capital appreciation.

Lastly, rising interest rates can negatively impact utility stocks as these companies tend to carry substantial debt due to the capital-intensive nature of their business. Higher interest rates increase their debt burden, affecting their profitability and potentially discouraging investors who may shift their funds to other asset classes.

In summary, while utility stocks offer stability and consistent dividends, they also come with drawbacks, including limited growth potential, regulatory challenges, market risks, and sensitivity to rising interest rates. Investors should carefully consider these factors before making investment decisions.

The types of utility stocks

The utility sector is one of the 11 major groupings of the Global Industry Classification Standard (GICS) and it includes five subgroups:

• Independent power and renewable electricity producers
• Energy distributors
• Energy service operators
• Natural gas suppliers
• Water and sewer utilities

Within the utility sector, two companies classified as utility stocks at a high level can be very different. For example, some electric utilities own and operate their own power generation facilities, while in deregulated electricity markets, energy traders and independent firms can service customers by "renting" third-party transmission infrastructure.

Utility stocks are often favoured by income investors, as they tend to offer stable and consistent dividends. However, they may be less appealing to growth investors due to their limited prospects for tremendous growth.

The best utility stocks to buy now

Utility stocks are considered a safe investment option due to their stable nature and ability to provide income while reducing volatility in an investment portfolio. These stocks are part of a regulated industry with fewer competitors, and their cash flow and profits are highly predictable, allowing them to pay consistent dividends.

NextEra Energy, Inc. (NEE)

NextEra Energy is one of the world's largest utility companies, specialising in renewable energy generation. The company owns Florida Power & Light Company, serving over 5.7 million customers in Florida, and NextEra Energy Resources, the world's largest generator of renewable energy from wind and solar power. It also generates clean electricity from nuclear power plants.

The Southern Company (SO)

The Southern Company provides electric and natural gas utilities to 9 million customers across three states and natural gas distribution in four. It is committed to environmental initiatives, having reduced its greenhouse gas emissions by 47% since 2007 and targeting net-zero operations by 2050.

Duke Energy Corporation (DUK)

Duke Energy is a Fortune 150 company, providing electric and natural gas utilities to millions of customers across multiple states. The company is pursuing a clean energy transition plan, aiming for net-zero methane emissions and a 50% carbon reduction by 2030, with net-zero carbon emissions by 2050.

National Fuel Gas Company (NFG)

National Fuel Gas Company is a diversified, vertically integrated natural gas utility company. It has experienced significant growth and profitability, benefiting from strong demand and the regulatory environment. The company has paid dividends for 119 consecutive years and raised them for over 50 years, offering a forward dividend yield of 2.41%.

NRG Energy, Inc. (NYSE:NRG)

NRG Energy is an integrated power company delivering electricity and related products using various energy sources. It has a strong growth outlook, acquiring Direct Energy and signing renewable Power Purchase Agreements. NRG has a solid dividend scorecard, with nine years of consecutive dividend payments.

Vistra Corp. (NYSE:VST)

Vistra Corporation is a top momentum stock, outperforming its sector peers with strong overall factor grades. The company is in the business of retail electricity, natural gas, wholesale energy, and commodity risk management. It has a strong balance sheet and is committed to returning capital to shareholders through stock repurchases and dividend payments.

Dominion Energy, Inc. (D)

Dominion Energy supplies energy and electricity to about 7 million customers across 13 states. The company invests in renewable energy production facilities and has committed to achieving net-zero carbon dioxide and methane emissions by 2050.

Vidler Water Resources Inc. (NASDAQ: VWTR)

Vidler Water Resources focuses on developing reliable water supplies in areas lacking water resources. The company identifies, acquires, and develops water rights and has seen significant revenue growth, with VWTR stock increasing by over 70% in the past year.

Waste Management Inc. (NYSE: WM)

Waste Management is a leading provider of comprehensive waste management services in North America, serving approximately 21 million customers. The company has a large trucking fleet in the waste industry and has seen a 24% rise in WM stock value over the past year.

Essential Utilities Inc. (NYSE: WTRG)

Essential Utilities is one of the largest publicly traded water, wastewater, and natural gas providers in the U.S., serving approximately 5 million people across 10 states. The company has a strong track record of regulatory compliance, operational efficiency, and environmental stewardship.

Sempra Energy (NYSE: SRE)

Sempra Energy received a long-term issuer default rating of 'BBB+' from Fitch Ratings, citing stable cash flows from its utility business and long-term contracted infrastructure investments.

The outlook for utility stocks

Utility stocks are a good option for investors looking to reduce risk and stabilize their dividend income. They are considered a safe investment because they are part of a regulated industry with fewer competitors. Utility companies provide essential services like electricity, natural gas, and water to homes, schools, and businesses, so they enjoy stable demand and predictable cash flow.

Utility stocks are less volatile and more dependable, especially during difficult economic times. They are also known as defensive plays for an investor's portfolio because they represent resources that are needed regardless of the economic cycle.

The shift to clean energy and electric cars is expected to make the utilities sector more of a growth sector over time. The Inflation Reduction Act of 2022 is expected to catalyze and accelerate the transition to renewable energy sources, and companies that invest in expanding their renewable energy fleets are expected to benefit.

However, the shift to clean energy also presents challenges for established companies, and some may struggle to adapt to new technologies and changing government regulations.

Overall, the outlook for utility stocks is positive, especially for companies that are investing in renewable energy and have stable regulatory environments.

Frequently asked questions