Which Utility Is Worth Buying?

Bob is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Utilities are the classic “widow-and-orphan” stocks. This phrase is most closely associated with stocks that provide reliable returns over time, ideal for investors who shy away from volatility. For investors who value stocks that pay high dividends, such as those investors in or nearing retirement, utilities have been relied upon as steady providers of dependable income for many decades.

While earnings per share growth isn’t going to take anyone’s breath away, utilities operate in a highly regulated industry and thus aren’t likely to collapse. Utilities are therefore critical to the prosperity and security of the nation. Even in a dire economy, utilities provide investors the certainty of reliable earnings and dividends.

There are many publicly traded utility stocks for investors to choose from. Two of the most well-known are Southern Company (NYSE: SO) and Duke Energy (NYSE: DUK), which both provide dependable results and carry hefty dividend yields. Are these two worth buying? Or is there a better utility to buy today?

The downside of slow-and-steady stocks

As previously mentioned, utilities are valued highly by many investors for their strong dividend yields and reliable results. These stocks are also not very volatile, which helps investors sleep at night, knowing they likely won’t wake up the next day to find their utility stock had gone out of business.

There’s of course a cost for this dependability, which in the case of utility stocks, is low growth. Southern Company and Duke both yield in excess of 4% at recent prices, but they have been slow to grow their dividends over the past several years.

In fact, five-year compound annual growth in dividends for Southern and Duke Energy is just 4% and 3%, respectively.

Moreover, earnings growth for Southern and Duke going forward isn’t likely to justify the fairly exorbitant valuations both stocks enjoy. Southern Company reported fiscal 2012 earnings per share grew 5%, while Duke Energy’s adjusted diluted EPS actually fell 1% last year.

However, none of this should be taken as a surprise. Utilities are never going to be high-growth stocks. What disturbs me most about Southern and Duke Energy are their valuations.

Each stock has rallied considerably over the past couple years. As a result, investors are now paying hefty prices for these stocks in search of yield. To illustrate, consider that each of these two stocks currently trades for more than 18 times trailing EPS. Plainly stated, there isn’t much underlying value left in these two stocks.

There are still reasonably priced utility stocks out there

Fortunately for investors, not all utilities trade in excess of 18 times trailing earnings while simultaneously offering little underlying growth.

For example, PPL Corporation (NYSE: PPL), is a $17 billion provider of electricity in the United States and the U.K.

PPL had a solid 2012, reporting $2.60 per share in full-year profits. That means that at recent prices, PPL trades for an attractive 11 times earnings.

Moreover, PPL’s dividend yield compares favorably to many competitors in the utility sector, where strong share price gains over the past year have widely depressed yields. Whereas Southern and Duke yield less than 4.5%, PPL yields 5% at its recent levels.

The Foolish takeaway

If you’re an investor who prefers to not have to keep your eyes glued to every piece of market-rattling news, these stocks can provide a necessary dose of stability to your portfolio. Electricity is something people will use regardless of the prevailing economic environment, and as a result, these stocks will keep profits and dividends flowing to investors for many years to come.

Within the utility sector, PPL looks to be one of the best of the bunch. The company is trading measurably below where most of its peers trade, and as a result, I view PPL as one of the few utilities that still has room to run.

Moreover, PPL’s dividend yield is almost 50 basis points better than both Southern Company and Duke Energy, and as a result, is the best choice for investors who need current income. In light of all this, investors looking into the utility sector would be wise to give PPL preference.

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Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends Southern Company. 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!

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