A Utility Stock Poised to Outperform

12/22/2009 9:26 am EST

Focus: STOCKS

Jack Adamo

Editor, Jack Adamo's Insiders Plus

Jack Adamo, editor of Jack Adamo’s Insiders Plus, says utilities have outperformed the broad market recently, and he finds one he thinks is in particularly good shape.

All year I’ve been more comfortable with high-income stocks than the so-called growth variety. I predicted the former would fare better as the market began to question the strength of the economic recovery. That trend now seems to be picking up steam.

High-dividend master limited Partnerships have been stronger than the market for the last three months, and utilities have kicked in during the last six weeks. Both groups still have excellent yields, prospects for modest growth, and are more economically solid than the broad market, [which seems] to be taking a breather now, but [has] shown no sign of rolling over yet.

I expect these trends to continue. Although the recent jump in utilities could pull back a little before climbing further, valuations are still very reasonable and the fundamentals for both industries are strong. They won’t need much to push them higher.

Although year-over-year comparisons will be weak for another few quarters, long-term prospects are good for both groups. Natural gas prices are expected to remain low for years to come, due to massive new shale gas discoveries.

Utilities are converting more capacity to natural gas to exploit this fact. That’s good for utilities because it produces cheaper, cleaner energy, and it’s good for the pipeline business because they’ll be moving more natural gas.

We will double our position in Southern Company (NYSE: SO) from a 4% to an 8% portfolio weighting. The most solid and steady of the group, it has 4.4 million customers in the southern US. It has a yield of 5.3% at its current price, a payout ratio of 74%, and a ten-year total return of 165%, beating not only the S&P 500, but the utilities as a whole.

The shares [closed Monday below $34—Editor.] Buy Southern Company up to $34.50 [or even a slightly higher top buy limit], raised from $34.50 to $36. This stock belongs in your income portfolio, although it should provide a total return worthy of the regular capital-gains-oriented portfolio.

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