Utilities: Safety and Yield

04/18/2017 2:50 am EST

Focus: UTILITIES

Richard Stavros

Analyst, Global Income Edge, Utility Forecaster and Personal Finance

Safety never goes out of style in our Income Portfolio, no matter how optimistic or jittery the market may be, asserts Richard Stavros in Investing Daily's Personal Finance.

So we thought this would be a good time to talk about our portfolio’s safest investments based on one of our proprietary stock selection models, which helps us evaluate and monitor dividend safety.

After reviewing our portfolio, we found that two electric utilities, Next­Era Energy (NEE) and Eversource (ES) have some of the best track records for safely generating strong returns on equity, making these investments excellent bets for weathering volatility.

When comparing companies with their peers, return on equity (ROE) is a key metric used by many of the world’s top investors, including Warren Buffett. A Schwab study compared 3,200 dividend-paying stocks by market cap over nearly 20 years and found those with higher ROE were less likely to cut dividends.

Eversource Energy and NextEra Energy had more than 17 consecutive quarters in which return on equity grew at least 2% because of rising profitability. They offered the strongest ROE performance in our portfolio by a mile based on their double-digit profitability.

With low betas, their share prices tend to fluctuate less under any conditions and hold their value better in a falling market. Plus, the financial guidance for both firms this year has been consistent with their past ROE performance.

Other attractive features of the three companies also contribute to dividend safety. For example, NextEra Energy has demographics on its side. The utility operates in a state with a growing population: Florida, where baby boomers are flocking to retire.

Regulators, though, are unlikely to approve NextEra’s plans to acquire Texas utility Oncor. Nevertheless, we believe as the demand for electricity rises from Florida’s expanding population, NextEra’s earnings will enjoy similar growth.

We’re already getting a preview of the effect higher earnings can have on dividends. In February, Next­Era Energy raised its quarterly dividend 13% and is aiming for 12% to 14% annual growth in dividends per share in fiscal 2018.

As a wires company, Eversource Energy is insulated from the fluctuating prices of coal, oil and natural gas, which can hurt many energy-producing utilities.

Because wires companies are energy distributors, they also benefit from the growing volume of energy produced, including renewable energy like solar and wind.

In its last earning call, Eversource forecasted earnings per share of $3.05 to $3.20 for 2017, and thanks to the firm’s capital investment plan, Eversource expects earnings per share to grow from 5% to 7% each year through 2020.

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