Utility Stocks - slow and steady growth as well as retirement income: these aren't just your father's investments

This week I'm going to talk about Utility stocks.  Let's start by defining what exactly a Utility stock is.  According to Dictionary.com, a utility is:

...a public service, as a telephone or electric-light system, a streetcar or railroad line, or the like...

So a Utility stock, then, is stock in a company that is considered a public service - like the phone companies, or companies that generate electricity or provides natural gas.

Nuclear Power Plant in Dukovany.  From https://upload.wikimedia.org/wikipedia/commons/d/d3/Nuclear.power.plant.Dukovany.jpg

That definition of a Utility is just fine, really.  For probably the last 100 years folks like Warren Buffet and my Dad have made good money investing in Utility stocks and reinvesting the dividends.  Because, you see, that's what makes a Utility stock so appealing - most of them make a nice, regular profit - they're selling something that people always have to have, regardless of the state of the economy - and they pass a nice chunk of that back to their investors.  It's not at all uncommon to make anywhere from 5-8% profit per year from an investment in a Utility company.

My Dad started out buy investing in just one company - Southern Company (SO), which produces electricity for much of the South.  He was lucky in that Southern Company did well, but as soon as I knew a bit about investing and realized what he was doing, I convinced him to diversify into other stocks.  Since my father is retired, he wanted to stick with dividend income - and since he already believed in utilities, I convinced him to go for other energy companies.  Let's take a look at some of the holdings that he (and I) own:

Stock	Current Price	Dividend	Yield
CTL	30.11	0.54/share	7.10%
DUK	74.13	0.82/share	4.30%
FTR	5.43	0.10/share	7.90%
KMI	17.77	0.125/share	2.80%
SO	48.33	0.54/share	4.40%
T	37.09	0.48/share	5.10%
VZ	51.02	0.56/share	4.40%

In my opinion, telecomms are really the new "power utility".  In 2007, with the advent of the iPhone, cellular phones took a quantum leap forwards in terms of functionality and data consumption - which in turn propelled cellular stocks upwards.  They've become another one of those things we can't do without - look around you and you'll see that even folks who have less disposable income are constantly staring into their smartphone screen.  Another reason to love the telecomms - many of the companies that are considered telecomms also form the backbone of the internet - companies like CenturyLink (CTL), AT&T (T), Sprint (S), and Verizon (VZ) make quite a bit of their money by routing data for businesses as well as consumers.  And I'm pretty sure this here internet thing is here to stay.

Now, if you recall from my earlier blog post, dividend investing is the slow but sure way to make a ton of money.  So why wouldn't you just stick all of your money into the utility company with the highest yield?   Several reasons:

Some stocks pay a stupidly high dividend because they are desperate to get investors - never a good sign.  If you take a look at Dividend.com you'll find companies paying as much as 20% dividend yield - mostly real estate investment trusts.  My advice is to stay well clear of them if you value your money.

All of the stocks in the above table pay a high dividend, but aren't classified as honey traps - they have been around for a long time and have paid a dividend more or less consistently for years (decades in most cases).

Additionally, you really have to diversify - you can't put all your eggs in one basket, because if that basket breaks, you lose your eggs.  Same thing here.  I love Frontier Telecommunications (FTR), with it's high dividend and low entry price per share, but it's a smaller company - it's been around for a long time (I've been making money from it for a decade), so I feel like it's stable enough, but with a smaller customer base (they serve the rural markets that the bigger providers can't be bothered with) and smaller total market cap, it's definitely less secure than a company like AT&T (T), which is essentially "too big to fail".  Bear in mind that while each of these companies offers a service that we "have to have", we don't have to have it from any one particular company.

The idea of diversification can - and should - also be applied to each market sector (such as utilities) you invest in as well - don't put all of your money into power companies, for example - add telecomms to the mix.  One good reason for this is that, every few generations, there is a paradigm shift - a major change in the way the system of our world works, and that can drastically impact the companies that do business the "old" way.  For example - we've been generating electricity pretty much the same way forever - we use a fuel that heats water that turns into steam that turns a turbine that drives a dynamo that generates electricity.

From
http://www.engineeringexpert.net/Engineering-Expert-Witness-Blog/tag/thermodynamics

It doesn't matter if you are talking about a coal-fired plant, a gas burning plant, or a nuclear power plant - they all essentially do the same thing:  heat water until you get steam, then use that to drive a generator.  Even if we succeed in getting nuclear fusion reactors operational, they'll still just be used to heat water - nothing as exotic as a electro-plasma conduit that generates power using unexplained technobabble is anywhere in our near future.  And that pretty much means that there will always be a large, central power-generating plant, owned by a utility company that we can invest in - right?

Not necessarily - there are disruptive technologies being worked on that could change all of that.  What if you could generate all the electricity you needed locally - say, in your home - instead of having to have a central generator that then distributes power everywhere?  Think of all the infrastructure we wouldn't have to build or maintain - no more wires or transformers!  Solar and Wind power are the first things people think of when they think about getting off the grid, but there's another option that's coming along fast - fuel cells.

http://www.bloomenergy.com

Bloom Energy is betting big that their Bloom Energy Server - a large array of efficient fuel cells taht generate electricity on-demand - will become an option to central power generation and distribution.  Their systems are already being used by several large name companies, including Apple, eBay, Google, FedEx, and Macy's.  In theory, this sort of appliance could live in your basement, next to your furnace and water heater, and produce all the power you need to run your home.  If this idea takes off, the traditional utility companies may start to die off.  Granted, it will take years - decades, really - if it ever happens, but it's important to realize that nothing is forever.

So how can you future-proof your investments against such disruptive paradigm shifts?  It's not always easy to see paradigm shifts coming, so you have to pay attention.  Spend some time every day, or week, or month, researching the things you invest in - and not just financial blogs, but the science and technology sites that affect that market sector.  And when you see a potential game changer like Bloom Energy, you keep it in your sights - maybe when the have their IPO you invest in them (as of this writing Bloom Energy is still privately held), or maybe you invest in companies that provide the fuel for the fuel cells (after all, they don't make electricity of of thin air - not yet, anyway).  Companies like Kinder Morgan (KMI), for example, who make their living moving fuel from one place to another via pipelines.  As an aside, Kinder Morgan has recently moved sharply lower - they had to drop their dividend payout temporarily, but they're still as profitable as ever - and I'm betting the dividend pops back up to it's previous 7% or so before too long.  They're one I'm going to stock up on as long as the price stays as low as it is.....

Next week I'll focus in one one utility stock in particular that I think is a worthy addition to your portfolio.  Until then, do some research on your own, and leave me a message if you think you find something interesting!

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Disclaimer - I am not a financial expert and I am not responsible for any losses - or gains - you may make if you make decisions based on the information posted here.  If you do make money, please feel free to let me know!

Disclosure - Wolfgang Rumpf owns shares in Apple (APPL), Kinder Morgan (KMI), Frontier Telecommunications (FTR), Centurylink (CTL), Verizon (VZ), Southern Company (SO), Duke Energy (DUK) and AT&T (T) mentioned above.