Piped-in profits

Utilities may not be the sexiest stocks, but when it comes to steady returns, boring can be beautiful

By David Berman
Globe Investor Magazine online, February 19, 2009

When investors label a stock "boring," you have to wonder if they really mean it as a compliment. If boring means that a company faces little competitive threat, produces steady earnings and announces rising dividends, then it certainly sounds like a good thing. That's why many investors have embraced the dullness of utilities.

The definition of a utility can be broad. It can mean power generators, natural gas distributors, telecom providers and pipelines. However, they all tend to be old companies operating in highly regulated environments and providing essential services to a wide population.

Miller/Howard Investments looked at the returns from utilities between 1945 and 1990, a 45-year period that accounts for changes in the business cycle and shifts in investor trends, and found that utilities delivered a total return of 11.7% a year, or just half a percentage point less than the S&P 500 index. Here's the kicker: Utilities delivered that return with about half the volatility.

One of the ways utilities have delivered this steady performance is through fat dividends. For example, AT &T has a dividend yield of 5.8% after boosting its dividend by 2.5% in December. In Canada, TransCanada Corp. has a yield of 4.4%, and TransAlta Corp. has a yield of 4.9%.

But utilities also have a number of operational quirks that give them advantages. For one, many utilities in North America have regulated rates of return-essentially, profits that are set by administrators. These rates usually range between 9% and 10%. The other big advantage is that many utilities are the only players in their respective markets. This isn't to say that utilities have come through the current bout of stock market volatility without a scratch.

Most are down sharply, as investors show little discernment among stocks when they run from the market. Still, utilities have fared better than the overall market. In Canada, utilities lost 25%, versus a steeper 33% drop in the S&P/TSX composite index in 2008. In the U.S., utilities fell 29%, versus a 37% drop for the S&P 500.

"If you look at a chart of electricity production, it basically goes constantly up with GDP growth or without GDP growth. If you look at a long-term chart of production for almost anything else, it goes up, it goes down, it goes up, it goes down," says Lowell Miller, Miller/Howard's founder. If that motion is making you sick, utilities can provide the stability you need.