Are Utilities a Good Buy?
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Utilities have long been called boring stocks and the kind that Grandma likes to invest in. Peter Lynch called them low growth in his book "One Up on Wall Street." He usually didn't touch them.
Over the past 20 years, the Dow Jones Utility Index has advanced at a compounded annual rate of 3.6%. Since 2008, the index has actually dropped 4.5% with most of the loss occurring within the past few weeks. Factoring in inflation, the real gain over the past two decades has been less than 1% per year.
A bright spot for the industry has been a nice stream of dividend payments, typically in the range of 3% to 4% per year, higher than most industries.
Interest rate risk in utilities?
Due to the fact that interest rates will probably rise when the Fed stops its bond-buying program, and we have even seen an uptick in rates over the last few weeks in anticipation of that happening down the road, will investors move away from utilities (and other defensive stocks) and look for yield elsewhere? That is a possibility. Since May 1, the utility index has dropped by 8.5%, wiping out the gains since the financial crisis ended.
Utility to join insurance and railroads?
Now that a unit of Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) thinks that utilities are the way to go, should the average investor consider the industry in spite of the risks and the low-growth performance of the past?
Berkshire's Des Moines, Iowa energy subsidiary, MidAmerica, will pay around $10 billion in cash and debt to buy Nevada utility NV Energy (NYSE: NVE)). The deal is subject to shareholder and regulator approval.
MidAmerica's goal is to add NV Energy's renewable technologies to its $66 billion business and to position itself to take advantage of growth in the state of Nevada.
Over the long term (since 1993), NV Energy's stock has under-performed the overall utilities index, increasing only at a compounded annual rate of 1% per year, lagging the market and not keeping up with inflation. It does pay a nice dividend of $0.76 per share and yields 3.2%.
The company has improved things recently with earnings growth in the double-digits since 2010. The stock is up too, mainly because of the recent buyout news. Revenue, however, has been decreasing.
Another utility having some issues right now is Dominion Resources (NYSE: D), which supplies energy needs in Virginia and a section of North Carolina.
Earnings (-28%) and revenue (-5%) have been declining over the last few years. It can't be considered a value play right now as the P/E ratio is approaching triple digits. In a bright spot, the company has been able to keep increasing its dividend in spite of the lack of growth. The stock has also dropped recently due to the uptick in interest rates.
So unless interest rates hold steady or drop, it might be wise to hold off on purchasing any utility stocks unless you can find a bargain out there. Rates will probably go up, especially when the Fed stops printing money.
If you have any utilities in your portfolio right now and typically hold for the long term, rates will probably stabilize at some point and you will probably continue to see the typical low growth and dividend payments that the industry has provided in the past.
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Mark Morelli has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway and Dominion Resources. The Motley Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!