Not All Utilities Are Created Equal

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Utilities are your classic slow-and-steady stocks. Since they operate in a highly regulated industry that is critical to our national security, the majority of publicly traded utilities represent just about the safest stocks you can buy.

Utilities are known for dependable profits and making quarterly dividend payments like clockwork. Investors own them much more for income purposes than capital gain potential. At the same time, utility stocks are still stocks nonetheless, and investors carry the risk of taking an equity stake in a utility company. In recent months, we’ve seen some divergences occur among the utilities. In that vein, here are two utilities you can buy today, and one to stay away from.

Dependable sources of income

Utilities like Southern Company (NYSE: SO) and American Electric Power (NYSE: AEP) are highly valued by investors for their ability to pay dividends year in and year out, regardless of how the economy is doing.

Even when the economy goes into a recession and the stock market plunges, consumers will keep the power on, and as a result utility stocks tend to hold up. And, since utilities manage to pass on rate increases on a regular basis, many utilities have actually increased their dividends for many years in a row.

To illustrate, consider that Southern has paid dividends for 263 consecutive quarters—dating back to 1948. Moreover, the company has actually managed to increase its shareholder distribution for 12 years in a row.

American Electric Power has a proud dividend history itself. AEP has paid a cash dividend on its common stock every quarter since 1910. Even better, AEP very recently increased its dividend by more than 4%.

This utility is falling behind

Bucking the trend of reliable dividends from utility stocks was Exelon (NYSE: EXC), when it cut its dividend earlier this year. As previously mentioned, utilities are overwhelmingly bought and owned for their fat dividend yields. A utility that cuts its dividend is failing at the biggest reason for owning it, and as a result, will see its stock drop in tandem.

That’s exactly what happened to Exelon, which had traded well above $40 per share for much of the past several years, after it slashed its dividend by 41%. The stock price followed suit, collapsing to its current level around $30 per share.

It appears that no utility is immune from the devastating effects of a deteriorating business. In the company’s annual report, Exelon revealed that fiscal 2012 GAAP diluted earnings per share fell by more than 60% versus the prior year.

The company’s first-quarter results were equally concerning. Exelon reported a net loss in GAAP terms, compared to a $0.28 per-share profit in the first quarter last year.

On a non-GAAP basis, Exelon’s first-quarter earnings per share fell 18% year over year.

Exelon also provided poor guidance for the remainder of the current year. Management anticipates between $2.35 per share to $2.65 per share of operating earnings in 2013, representing a decline of 7% to 17% from fiscal year 2012 operating earnings.

Focus on the winners

I had previously owned Exelon for nearly three years, but sold it last year on concerns that the company’s dividend growth had stalled despite solid free cash flow generation. Perhaps management knew the company’s fortunes were about to turn.

Quite frankly, a utility should not have the amount of volatility in its underlying financial results than Exelon has in recent quarters. The business is virtually guaranteed; the industry itself is critical to the prosperity of our nation.

Investors simply don’t need to put up with a utility that reports losses and slashes its dividend by nearly half. There are plenty of other highly profitable, well-managed utilities that take their dividend obligations very seriously. Two of these, Southern Company and American Electric Power, maintain long histories of quarterly dividend payments, year in and year out, and should be given preference by investors interested in utility stocks.

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Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends Exelon and 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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