Some clients with growthy, tech-heavy portfolios become addicted to the excitement of such sexy stocks.
Yet in some market scenarios, there can be such a thing as too much excitement, especially for clients so enamored with growth that they stubbornly resist diversification afforded by less alluring sectors.
For these clients, helpful diversification and relative stability, along with good, reliable income can be found in utilities, a decidedly unsexy sector. The worst-performing sector in 2023, some utilities are battered to the point of being real bargains, considering their current rebound potential.
Utilities’ services and products are necessities—unless you live in a barn, and maybe even then. Everyone, rich or poor, usually pays their utility bill first, lest they end up without light, water, heat or air-conditioning. These reliable payments generate predictable revenues, sustaining dividends.
These stocks are far from sizzling, but a modest allocation can provide a measure of safety in turbulent markets. And unlike the growth stocks that really turn clients on, utilities will cuddle up with them during market storms, when sexier stocks suddenly don’t look as good.
Beauty Beneath The Skin
Though utilities stocks have become homelier over the past couple of years because of historically poor price performance, long-term historical averages—such as average annual growth of Select Sector UTI SPDR (XLU), the sector’s largest ETF, of 9.37% over the trailing 15-years as of Dec. 23, according to Morningstar—indicate that mean reversion may be overdue.
Demographic trends support the case for sustained or increasing revenues. Adding new customers may be iffy during some periods, but in recent years, the number of households in the U.S. have been increasing, a trend that analysts expect to continue indefinitely.
Millennials are buying their first homes, grown kids are moving out of their parents’ basements and people are getting divorced, with the result of one household turning into two. Households are also increasing from the associated trend of more and more Americans living alone. All of this means more meters.
So, hanging on to customers is likely, unless the population declines from the nation’s chronic low birth rate. Yet immigration levels more than compensate. And over the past few years, power rates have been increasing faster than inflation.
The result is many utilities have strong fundamentals and balance sheets. In particular, according to Morgan Stanley, the stocks of CenterPoint Energy (CNP), Southern Co. (SO), Public Service Enterprise Group (PEG). and Consolidated Edison (ED) will probably hold their values nicely next year from good earnings and strong balance sheets reflecting fundamental stability.
From an asset allocation standpoint, advisors seeking income through bonds would probably do better using utilities, as the 10-year Treasury rate hovered around 3.9% at Christmas (down from 4.3% earlier in December).
Income Over Growth
The current average dividend yield of XLU is nearly as high—about 3.78% as of Dec. 23, making this sector something of a bond surrogate in equity clothing.
Moreover, bonds of course never give holders a raise, whereas many utilities have a long history of consistently raising dividends. Some are in the venerable dividend aristocrat category: Consolidated Edison, Atmos Energy Corp and Next Era Energy. The latter’s stock price was still down 27% YTD as of Dec. 23 after having sprinted upward a remarkable 28.2% since Oct. 9.
Bargains among beaten-up utilities abound. When measured on a relative price-to-earnings valuation basis against the S&P 500, utility stocks are cheaper than they’ve been since 2009. And despite an uptick in the Santa Claus rally, as of late December, XLU was still down about 10% for the year.
Given their performance history, many utilities’ returns may not grow more than 6 or 7% annually over the next couple years. But typical dividend levels could easily put total returns in the low double digits—not bad for an equity safe haven and superior to yields of Treasuries and investment grade bonds.
Pessimistic clients still fearing a hard landing, despite mounting contrary indications, might take comfort in the sector’s long history of economic resilience, especially during a prolonged interest-rate plateau following a rate-hiking cycle that produced a slowing economy, like the current one.
Relatively Low-Risk Standouts
Our sector screens for a wide range of fundamentals metrics yielded more than a dozen names with the lowest measurable downside risk.
Of this elite group, six stand out for their advantageous combinations of dividend yields, P/Es and ROE, relative to their low-risk peers, as shown by metrics as of mid- to late December:
Eversource Energy (ES). Market cap: $20.84 billion. With one of the best dividend yields of the low-risk roster, 4.36%, this gas company has a trailing 12-month P/E of 17.8 and ROE of 7.55%.
Entergy Corp. (ETR). Market cap: $21.57 billion. This electric company has a trailing P/E of 14.7, a dividend yield of 4.48% and ROE of 11.16%.
American Electric Power (AEP). Market cap, $41.9 billion; dividend yield, 4.34%; ROE, 9.44%; trailing P/E, 24.6.
Consolidated Edison (ED), AKA Con Ed, a multi-utility. Market cap, $31.6 billion; trailing P/E, 13.51; dividend yield, 3.58%; ROE, 11.48%.
Edison International (EIX). Market cap: $25.9 billion. Not to be confused with Con Edison, this electric company has a dividend yield of 4.38%. Trailing P/E, 21; ROE, 8.58%.
Unitil (UTL), a holding company engaged in electricity and natural gas distribution, with a market cap of $824 million. Trailing P/E, 8.52; dividend yield, 3.05%; ROE, 9.45%.
Client portfolios long on sex appeal and short on stability can probably benefit from utilities’ portfolio-risk protection. These key defensive stocks can generally provide clients with figurative as well as literal warmth when growth stocks turn cold. And they’re all the warmer for their reliable income.
Dave Sheaff Gilreath, CFP, is a founding principal and CIO of Innovative Portfolios, an institutional money management firm, and Sheaff Brock Investment Advisors, serving individual investors. Based in Indianapolis, the firms manage assets of about $1.3 billion. Investments mentioned in the article may be held by those firms, Innovative Portfolios’ ETFs, affiliates or related persons.