A Utility That Could Survive a Selloff

02/04/2008 12:00 am EST

Focus:

Richard Band

Editor, Profitable Investing

Richard Band, editor of Richard E. Band’s Profitable Investing, says utilities are priced for perfection but he finds one that is reasonably priced and pays big dividends.

Utility investors are smiling these days—and for good reason. In 2007, the typical utility stock, as measured by the Dow Jones Utility Average, rolled up a fabulous 20% total return (dividends plus appreciation). Electric, gas, and water providers fulfilled their classic defensive role in a tough and turbulent market.

Over the past five years, the record looks even more impressive. A $10,000 stake in the average utility mutual fund has grown to more than $26,000, dwarfing every other major domestic fund category except natural resources. The normally slow-footed utes even left technology funds in the dust! We’ve held an overweight position in utilities (i.e., bigger than their weighting in the broad stock market indexes) for eons, so we’ve certainly benefited from the huge upswing of recent years.

But Mr. Market is a cranky guy. He gets a kick out of turning the lights off just when the partygoers are having the most fun. A year ago at this time, Wall Streeters were oohing and aahing over the stupendous gains notched by real estate investment trusts since the turn of the millennium. Suddenly, REITs stumbled. For 2007 as a whole, they lost 14%, even with dividends thrown in.

Why do I recite this cautionary tale? Because many utilities today have caught the same virus that laid the REITs low in 2007. Dividend yields have shriveled almost to the vanishing point. Thanks to the enormous run-up in share prices, the dividend yield on the Dow Jones Utility Average hit an all-time low of 2.7% in December and again in January.

When I say “all time,” we’re talking about a pretty long stretch of history—79 years, to be exact. The DJUA made its debut in 1929. Even in the Silly Sixties, when Wall Street touted utilities as “growth stocks” and promised that nuclear power would make electricity “too cheap to meter,” yields never sank as low as they are now.

In short, many utilities are priced for perfection, particularly those engaged in wholesale generation of electricity. Wall Street is assuming much faster earnings growth than these companies are likely to achieve over the long pull. If the slightest incident should come along to puncture investors’ dreams, more than a few stocks in the group could fall a long way.

Let’s not paint with too broad a brush, [however]. Some utilities are still quite reasonably valued. In fact, I’m hanging a four-star buy rating on NICOR (NYSE: GAS), the local gas distributor for Chicago’s northern and western suburbs. NICOR is throwing off a safe, steady 4.6% dividend that you can count on to pay your retirement bills. Buy at $44 or less. (It closed below $42 Friday—Editor.)

Subscribe to Profitable Investing here…

Related Articles on