Investors looking for a value investment that typically provides steady income without high volatility might consider investing in utilities. Utility companies provide essential services that the public uses on a daily basis, such as water and electricity, making them generally very valuable and stable investments.
Investing in utilities is considered to be low risk compared to other different types of stocks, since utility companies are regulated entities with few competitors. Plus, their profits and expenditures are very predictable, so they tend to be stable investments.
Utilities are a constant in modern life—people always need them—so utility companies tend to ride out economic downturns without significant volatility, while providing higher dividends than other fixed income assets.
What are Utility Stocks?
The utilities sector includes electricity, gas, water, and waste services. Cable and telephone companies used to be placed in the utilities sector, but now they are within the communications sector due to shifts in technology and competition.
The utilities sector includes companies that generate power and alternative and renewable energy, as well as companies that transmit and distribute power to homes and businesses. Companies that provide natural gas generally buy it from oil and gas drilling companies and distribute it to customers. Water companies provide clean water to customers and collect and treat dirty water.
Since there will always be a consumer demand for basic utility services, the sector continues to invest in infrastructure, resulting in continuous growth.
There are government regulations protecting utility companies, making it difficult for competitors to enter the market. Regulations also control the prices that utility companies charge for goods and services, making their earnings predictable and creating even more stability in the market. It’s also extremely expensive to build the infrastructure needed to provide utilities. This allows utility companies to establish themselves in a region and grow steadily over time without significant volatility.
Who Should Invest in Utilities Stocks?
Utility stocks are generally considered to be income stocks rather than growth stocks, since they provide consistent dividends but don’t tend to significantly increase in value.
Some people might be tempted to think of utility stocks as similar to bonds, since they provide consistent income and tend to be stable and safe. But they are not the same. One difference is that the yields from utility stocks tend to be higher than those of bonds and other fixed income investments. These factors make them popular as a safe haven asset, and among retirees and conservative investors.
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Choosing Utilities Stocks to Invest in
There are a number of ways to evaluate a stock in a utility company before buying it—here’s what investors might want to consider.
New Utility Companies and Emerging Markets
Since utility stocks have high dividends (making them popular monthly dividend stocks) and tend to be established companies, they don’t have the opportunity for significant growth. But some stocks in emerging markets or those of new utility companies can be an exception. Growth investors tend to gravitate towards these types of utility stocks, use utilities as a safe haven during market downturns, or as a way to diversify.
Companies with Moderate Dividend Payouts
Investors can look at a company’s dividend payout ratio to see how much of its profits it retains and how much it pays out to shareholders. If a company pays out less to shareholders, it may have more potential for growth since it keeps those revenues to invest back into the business and won’t need to borrow as much money.
Undervalued Utility Companies
Technical analysis can help both growth and value investors pick out which utility stocks might be undervalued and those which have the most potential for growth and income.
Utilities with Healthy Credit Ratings
Another tool investors can look at when choosing utility stocks is their credit rating. A higher credit rating means a company will be able to borrow more money, which is important for utility companies that need to continue investing in and maintaining infrastructure. However, too much debt isn’t a good sign, so investors should look at the company’s EBITDA (earnings before interest, taxes, depreciation, and amortization) and debt-to-total-capital ratios when comparing potential utility stock investments.
Other factors to consider when choosing utility stocks:
• The region in which the company operates
• The regulatory market in that region
• The utility the company provides and its business model
• The dividend rate
• The company’s financials
Investors who want to gain exposure to a broad cross section of the market rather than choosing individual stocks might choose to invest in utility ETFs and mutual funds.
Benefits of Investing in Utilities Stocks
There are several reasons investors choose to add utility stocks to their portfolio:
• They tend to pay out higher dividends than other fixed-income assets and stocks.
• They are considered safe and stable investments. There will always be a demand for utilities, investors tend to sell off higher-risk investments first, they are under government regulation, and they have few competitors.
• They tend to have high dividends and stability. Even though they don’t always see significant growth, their high dividends and low volatility make them a popular investment, so they do continue to grow over time.
• They can be a safe haven asset during economic downturns. Utilities provide essential services, making them a good way to diversify a portfolio.
• They have little competition. Government regulations create the opportunity for utility companies to essentially become monopolies within their operating region, reducing the ability for competitors to enter the market.
• Certain utility stocks may provide tax benefits. This can include lower capital gains rates for qualified dividends.
Downsides of Investing in Utilities
Although there are many reasons to invest in utilities, like any investment, they come with some downsides:
• They are riskier than bonds. Since they are still part of the stock market, their values do fluctuate along with market trends. Utility stocks lost about half of their value (not including dividends) in both of the major market downturns in the past decade.
• They don’t provide opportunity for significant short-term growth. Here, their stability can be seen as a negative.
• Rising interest rates can negatively affect utility stocks. That’s because utility companies tend to hold a lot of debt since their businesses require significant capital investment. As interest rates rise, companies have a higher debt burden. Also, when interest rates rise, stock prices tend to decrease, thereby decreasing their amount of equity funding and causing some investors to shift funds into other types of assets.
• Utility companies are affected by changes in government policy. Regulations can also make it challenging for companies to grow, since they can’t easily increase their prices.
• Not every utility company has high returns. The best choices for investors are the ones that show visible potential for both growth and high-yield dividends. Since utility infrastructure is expensive to build and maintain, companies need to show that they will be able to continue running and growing while still earning enough profit to pay out dividends.
Investing in utility stocks can be a good way to diversify a portfolio, by adding low-volatility assets that typically have high dividends. The public will always need utilities like water, gas, electric and renewable energy—and that allows utility companies to weather economic downturns relatively well.
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