How to find utility stocks to buy that will protect your money
For cash flow and safety, utility stocks are the best investments you can make but you have to know which ones to buy. How do you find the best safety stocks for your portfolio? How do you know which utility stocks will help you protect your money and collect that cash flow?
I’m screening through the 300+ utility stocks to find the best of the best to create a dividend portfolio that will protect your money.
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Why Every Investor Needs to Buy Utility Stocks NOW
To be honest, a lot of investors probably won’t watch this video. Utility stocks aren’t as sexy as tech and don’t pay the yields of energy stocks. Stocks in the sector have had a runaway year and valuations are a little expensive, so interest in utilities is way low right now.
But I’m glad you’re here because this is still a critical sector for your portfolio. I’m going to explain why utility stocks need to be in your portfolio, why they could produce double-digit returns in 2020. Then I’ll reveal five of the best utility stocks I found searching in a group of 300-plus companies.
It’s part of our 11-video series, uncovering the best companies in each stock sector. Over these 11 episodes, one for each stock sector, I’ll show you how to pick the best of breed in each. We’ll look at some of the big trends and how to pick stocks to buy, then I’ll reveal my five favorite stocks in each.
This is one of my favorite strategies and hugely powerful. Not only do you get the opportunity for market-beating returns with some of the best stocks you can buy, you get a diversified portfolio with investments from each sector in the economy. That’s going to help smooth out the roller-coaster ride in stocks and keep you from freaking out if we see a crash in the next year.
What are Utility Stocks?
Here’s that graphic again of the stock sectors and today we’ll be looking at utilities including electic and gas, water and renewable power companies.
The sector has had an amazing year, producing a 16% return over the last 12 months against a 12% return on the broader market. That’s not normal for utilities to outperform like that. Three interest rate cuts by the Fed really boosted this sector and investors are worried that returns going forward won’t be as hot.
But there are three reasons you still want to be watching utility stocks for your portfolio. First is that rates aren’t increasing, Fed Chair Powell has pretty much committed to no rate hikes unless inflation really takes off. This is at least going to be neutral for utility stocks and rates could actually fall a little further if economic growth continues to slow.
That could mean utilities fool the skeptics and post another runaway year in 2020.
Another reason, really a no-brainer, is that utility stocks pay some of the best dividends in the market. The sector pays a 2.9% yield and the five stocks I’ll share with you here average a 4% dividend yield.
Finally is that while the economy and the market seem to be holding up, you need that what-if insurance you get from utility stocks. The market has wobbled a few times over the last year and nobody knows when the next crash will come.
Utility stocks beat the market by 10% through the worst of the 2009 crash and the opportunity is there to protect your money even better by picking the best of breed companies in the space.
Three Utility Stock Funds for Your Portfolio
I want to get right into the two utility funds and five stocks I’m watching but if you’re just joining us, make sure you watch the first video in the series. Not only did I reveal five of the best tech stocks to buy right now but I detailed how I’m picking stocks for the series. In that video, I go step-by-step into the five criteria I used to find these best stocks.
As I’ve done in the other videos, I want to show you a couple of utility funds for that broad exposure to the theme. These are going to be great if you can’t find a company you really like or maybe just want a little more diversified exposure.
The Utilities Select Sector SPDR, ticker XLU, pays a 2.9% dividend and charges an expense ratio of just 0.13% which is one of the lowest you’ll find for a sector fund.
The fund holds shares of 28 companies in the theme, representing the sector so mostly in that electric utilities group but also some multi-line companies and other producers.
Another interesting fund for utilities exposure is the iShares Global Utilities fund, ticker JXI. Now the fund is a little more expensive with an expense ratio of 0.46% but pays a 3% dividend yield and gives you access to international utilities.
The fund holds shares of 66 companies with about two-thirds in the U.S. but a good mix of European companies and some others as well.
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Five Utility Stocks I'm Buying for 2020
Our first of five utility stocks is Dominion Resources, ticker symbol D, and a 4.5% dividend yield.
Dominion pivoted from an energy exploration company to a utility in 2017 but it still has some of the mid-stream assets that makes this a really interesting investment. The company owns a liquiefied natural gas export facility and is 48% owner of the Atlantic Coast pipeline project, as well as owning one of the nation’s largest natural gas storage systems.
This all makes for a more diversified investment and probably faster growth than a pure-play utility company. The regulated business contributes 45% of operating earnings so you’ve still got that safety play you get with utilities though.
Shares trade for just over 20-times earnings which yeah, is a little expensive. Earnings are expected 10% higher over the next year which is excellent growth for a utility and really speaks to those mid-stream assets.
That valuation is going to be an issue for most of these stocks and when we look at the analyst price targets. You see here a graphic of forward price-to-earnings ratios for each sector. The dark blue line is the current P/E while the green bar is the 10-year average PE ratio for the sector. At 20.1-times, the utilities sector is one of the most expensive in the graph and trading at a 30% premium to its 10-year average multiple.
Analyst price targets for Dominion range from a low of $76 per share to a high of $90 each which is only about a 10% return but remember it’s on top of that 4%-plus dividend yield.
Here I’m going to throw you for a loop and include Berkshire Hathaway, ticker BRK.B in our list of utility stocks.
Most investors don’t know that Warren Buffett’s Berkshire is also a utility company. You hear about the stock portfolio but actually 10% of total revenue comes from Berkshire Hathaway Energy which is a subsidiary. In fact, by sales BHE would be the nation’s third largest utility behind Duke Energy and Exelon.
Buffett likes to use the massive cash flow from the utilities business to invest in the stock portfolio. This means the company doesn’t pay a dividend, it’s only paid once in 1967, but it’s still a solid bet in the theme. Berkshire is sitting on a $128 billion cash pile and will probably either issue another special dividend or just buyback shares like it’s been doing, either way a boost to shareholder value.
You don’t get the kind of returns Buffett produces without paying for it and Berkshire shares trade for almost 22-times earnings. Earnings are expected nearly 8% higher over the next year and should beat expectations on a share buyback.
There’s only one analyst here with a price target so take this with a grain of salt. I’m showing it for continuity and I think that $242 price target is actually a little low considering the stock’s history of returns.
Exelon, ticker EXC, is the nation’s largest utility company by customer base with 10 million power and gas customers across six regulated utilities. Besides that traditional power and gas segment, Exelon is also the largest nuclear operator with 14 plants across North America.
Although the nuclear segment has struggled against low nat gas prices over the last few years, I like this diversification in businesses. Having both the traditional and the renewable segments helps Exelon in just about any pricing environment.
Shares trade relatively cheaply at 15-times earnings though you see that management hasn’t been as consistent at beating expectations as I would like. Earnings are expected 9.8% higher over the next year which could really drive the stock price if they can meet it.
Better analyst coverage here with 10 analyst price targets ranging from a low of $46 per share to a high of $55 each and a 22% return on the current price.
One of the few value plays left in utilities is Edison International, ticker EIX, with its 4% dividend yield.
Edison counts over five million customers in Southern California, excluding Los Angeles and is a fully regulated utility. The wildfires and a planned share issue have hit the shares but I think investors are confusing some important fundamentals here.
Management raised its full-year 2019 earnings guidance in the quarterly call but it got drowned out by the planned share issue to cover the company’s $2.4 billion payment into the California wildfire insurance fund.
In fact, the company’s exposure to the wildfires this year has been minimal but investors are having a hard time looking at Edison without thinking of bankrupt PG&E.
Shares trade for 14-times earnings which are expected to decline slightly next year on the share dilution but should rebound quickly. I think after the wildfire season and investors see that the company is safe, shares take off from here.
Analyst price targets range from $72 per share on the low side to $84 a share at the top end. The company spends just half its earnings to cover the dividend so lots of room for growth here and one of the few underpriced utilities around.
I like Duke Energy, ticker DUK, here as well but you might not want to hold both it and Dominion Resources.
Duke is the other major owner of the Atlantic Coast Pipeline project. The pipeline has come under legal problems with the Supreme Court agreeing to hear arguments in June or July of 2020. I think there’s a good chance the court overturns an appeals court ruling on the permitting which could lead to a pop in the shares of both companies but it could also go the other way and weigh on both shares.
Duke is the largest regulated utility by market cap in the U.S. with business in six states and seven million customers. Shares trade for 19-times earnings which are expected flat over the next four quarters. Analysts aren’t expecting much from the shares with a low target of $93 per share and a high of $99 a share. The fact that nobody’s expecting much could be what drives a better return on the shares though.
Utility stocks are the best investments you can make for dividends and cash flow but you can't just focus your portfolio on these. Make sure you check out those other videos in our sector stocks series to build the diversified portfolio you need to protect and grow your money. Click here to watch that first video in the series on the best tech stocks for 2020.