Utility stocks are one way for investors to generate income through dividends. They are a relatively conservative investment option which still allows investors higher returns than many other types of investments.
Utilities are companies which provide essential services to homeowners and consumers. These include things like electricity, water, and gas service. Regardless of the state of the economy, utilities will always be in demand, making utility stocks a much more stable investment than stocks that are dependent on more variable or mercurial areas of the market. Generally, utility stockholders are also less likely to sell their utility holdings during a downturn. Although utility stocks are seen as higher-risk than most bonds, they are considered to be on the lower-risk end of the stock market spectrum.
The main benefit of utility stocks is that their dividends are ordinarily above-market. The yields on utility stocks are typically between 1.75 and 2.5 times that of the S&P 500 index, while maintaining greater stability than the general market.
Conversely, utility stocks have a limited potential for capital appreciation. Because there is not significant room for growth for the utility companies, there is a degree of self-limitation for their stocks. This does, however, manifest in higher dividends, as the companies do not have many opportunities to invest in future growth and development.
In the long run, above-market dividends can make a significant difference in total return. Over the course of 15 years, one exchange-traded utilities fund (ETF) yielded a cumulative total return of 101.49% and an average annual total return of 5.05%, while the S&P 500 ETF yielded a cumulative total return of 70.44% and an average annual total return of 3.80%. This example demonstrates how even a few percentage points of dividend yield can add up and make a significant difference over time.
As with any stocks, utility stocks are vulnerable to market forces and changes. During the two most recent major market declines, in 2001-2002 and 2008-2009, utility stocks decreased in value by about half, not including dividends. Investors who are looking to utilize their investments for income should take this into consideration when deciding between investing dividend-paying stocks like utilities and bonds.
Additionally, two other factors can negatively influence utility stock performance. The first of these is rising interest rates. Rising interest rates increase the interest burden of utility stocks because utility companies are often capital-intensive, therefore the companies are more heavily indebted. Rising interest rates also tend to make investors who are primarily concerned with income to move toward bond investment and decrease their stock holdings because of increased risk. Secondly, utility stocks, due to the nature of the holdings, are based on companies that are closely regulated by the government, making utility stocks sensitive to any changes in governmental policy.
Investors interested in purchasing utility stocks can do so through any broker. Investors can purchase individual stocks, exchange traded funds (ETFs), or mutual funds that are focused on the utility stock sector. As always, investors should look into and investigate their options prior to investing and discuss concerns with a professional.
About Lawrence Meyers
Larry is regarded as one of the nation’s experts on alternative consumer finance. He consults for hedge funds and private equity via his Council Member status at Gerson Lehman Group, and as a member of Coleman Research Group’s Executive Forum. He also consults for Credit Access Businesses and Credit Services Organizations in Texas. His Op-Eds and Letters to the Editor have appeared in over two dozen major newspapers. He also brokers financing, strategic investments, and distressed asset purchases between private equity firms and businesses of all stripes. You can reach him at email@example.com.
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