Friday, July 12, 2013

Investing in Utilities

Let’s talk about something boring, utility stocks. Typically they don’t do very much but sit there and spit out dividends. I am holding pat until I have bought my new house and sold my old house. Then I will have to figure out where to put that money. One of the places I am considering is utility stocks. There are basically three kinds of utilities, electrical power generation and distribution, natural gas distribution, water companies that distribute clean water and clean up your sewage. Phone companies are kind of sort of utilities, but are generally not included in this class of stocks.

Currently I own both shares in an electrical and a natural gas utility. They could both be classified as solid base hits. Let’s consider Piedmont Natural Gas (PNY), a regional distributer located in the Carolinas and Tennessee. About seven years ago I bought 550 shares at $24.27 for a total investment of $13,348.50. Today after reinvesting dividends I own 702.4431 shares valued at $34.50 a share. That totals out to $24,234.29. Nothing to write home about, but a pretty decent return over a period of time that included the crash of 2008. Schwab provides its clients with reports predicting the future growth of most companies. Generally, they rate PNY as a D. On a scale from A to F a D is a recommendation to sell. PNY doesn’t grow very fast, but it is a well managed profitable little utility that has provided me a decent return without a lot of risk.

Utilities are by their nature monopolies. Try and open a new natural gas distribution network in Charlotte, good luck. There would be no point for a competitor to put that kind of capital in an investment that could not possibly be profitable. Because utilities are monopolies, they are regulated by law. This means that they are guaranteed a reasonable profit by state governments. A reasonable profit includes a respectable dividend. These companies typically pay out 60%-80% of these guaranteed profits to me, the shareholder. If I continue to hold on to these shares for at least 60 days during the 121 day period following the ex-dividend date, my dividends are classified as “qualified dividends.” This means I will pay long term capital gain taxes on this income rather than the higher tax rate applied to ordinary income.

Because utilities have a captive clientele, they rarely go out of business. Because their profitability is guaranteed by governmental agencies their dividend tends to increase with inflation.

Are there reasons not to invest in utilities? The big reason is that you are not likely to see much growth in these stocks. There is risk to your principal. If there is an accident at one of your nuclear power plants, you can kiss a good portion of your money goodbye. If your company has too many aging coal burning power plants it is likely that company will have to raise large amounts of money to modernize their equipment. The cost of that capital (bonds and new issues of preferred shares) will come out of your hide, unless you buy some of those new issues. Hmmm….

Of course, governments may get feisty and uncooperative about granting rate increases when the electorate is screaming bloody murder. Governments that are powerful enough to guarantee a return on your investment are powerful enough to take it away.

I have owned shares in a water company on two separate occasions. Both times I made money. It seems that some jurisdictions that currently have publically owned water distribution systems are exploring the privatization of these assets. This may be an opportunity for regulated water utilities to expand, if the price is right. I will be looking into some of these opportunities once the dust settles from my impending move.

As always: Please. Please. Please. Let’s be careful out there today.

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