With the long-term viability of the business unchanged and profitability guaranteed by highly regulated contracts, use this temporary drop in prices to lock in a higher yield on these two safe income stocks.
For the first half of 2016, investors flocked to what are viewed as safer stock sectors including REITs, consumer staples companies, and utilities. Recently, market sentiment has shifted dramatically and money is going to riskier stock sectors and the “safe” types of stocks have been falling in value. My contention is that lower share values just make utilities as income investments even more appealing.
A recent article on Seeking Alpha titled “The Fear Trade Is Falling Apart” provides how the financial news outlets and, by extension, a lot of individual investors think about the stock markets. Everything is a “Trade”, trying to obtain a short-term advantage or gain. Unfortunately for most investors, following the popular “trades” is a good way to end up buying high and selling low, thus losing money. With income stocks like utilities, I recommend thinking like an investor. To “invest”, we want to buy into companies that will grow and pay attractive dividends. With an investor mindset, a lower share price on a company we like looks like a good deal. I like the idea of buying when others are selling, resulting in a buy low, earn a nice income stream and sell high if my stocks again become part of a hot “trade” strategy.
The utility sector story is pretty straight forward. The businesses –electricity, natural gas, water– of these companies are highly regulated. In most areas, the regulatory agencies let the utilities set rates so that they can pay to keep their equipment up to date and earn a reasonable return on their equity. As long as the management team of a utility doesn’t mess up, you end up with a stock that pays an attractive dividend yield and will increase the dividend by a moderate amount every year. On average, what you get with utility stocks is something around a 3% to 4% yield and 4% to 5% annual dividend growth. If you get share price growth to equal the dividend growth, you end up with an average of 8% to 9% annual returns over time. Remember that these are conservative stocks, with much less volatility than the overall stock market, so a high single digit annual return is a nice reward for going that conservative. Also, utilities tend to
On average, what you get with utility stocks is something around a 3% to 4% yield and 4% to 5% annual dividend growth. If you get share price growth to equal the dividend growth, you end up with an average of 8% to 9% annual returns over time. Remember that these are conservative stocks, with much less volatility than the overall stock market, so a high single-digit annual return is a nice reward for going that conservative. Also, utilities tend to outperform when the market and economy are going through tough times. For the long-term focused investors, utilities will produce decent returns combined with less of that volatility that can keep you awake at night.
Several times a year, I meet up or have phone interviews with the portfolio managers at Reaves Asset Management. Reaves specializes in the utilities sector and has been doing so since 1961. These are the folks I go to when I want to learn more about utilities and get caught up on the current trends in the sector. Besides managing money for institutional investors that want utilities sector exposure, Reaves manages a pair of publicly traded funds that have generated better than the sector average returns.
The Reaves Utilities ETF (Nasdaq: UTES) is an exchange traded fund that was launched about one year ago. UTES is one of the new breeds of actively managed ETFs. This means that instead of just buying utility stocks to match an index such as the S&P Utilities Index, the managers pick the stocks and weightings of the utility companies owned by the fund. The focus of the UTES fund managers is to own those utilities that will steadily and regularly increase their dividends. During our last conversation, a couple of the managers noted that the utility stocks with higher yields tend to be overvalued by the market and those with lower yields, but higher dividend growth rates, are undervalued. Since it was launched, UTES has beaten the results of the Utilities SPDR ETF (NYSE: XLU) by 3.5% in total return. You can expect UTES to yield around 3% with share price growth driven by dividend increases.
Reaves Utility Income Fund (NYSE: UTG) is a closed-end fund that is more focused on current yield and income. The fund was launched in February 2004. UTG pays monthly dividends, it has never reduced its dividend rate, and the payout has been regularly increased. Last week, the monthly dividend was boosted by 5.8%. The dividends from UTG are a combination of dividend income from the portfolio and realized capital gains from the portfolio. The fund has never had dividends classified as return of capital. UTG currently yields 6.5%.
The two funds let you pick based on your investment goals. If you want to build wealth conservatively over time, look at UTES. For current income at an attractive yield, consider UTG.
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