These Payouts Are Electric

12/07/2011 11:43 am EST

Focus: STOCKS

Josh Peters

Editor, Morningstar DividendInvestor

One’s a major monopoly utility and the other hasn’t been for a long time, but both are promising dividend plays, says Josh Peters, editor of Morningstar DividendInvestor.

Josh, I’m looking for income in all the right places. Direct me.

All right. Well, I’ve got to start, you know, with the big picture, which is, I think the stock market actually has a lot of very good income-generating opportunities right now.

When you look at how low interest rates are in the Treasury market, and in your bank CDs, it’s not that hard to find dividends that—perhaps they’re not guaranteed, but I would deem very reliable as a long-run investor—that have yields of 3%, 4%, on up to 6%, and in some cases beyond.

You don’t want to go too high. You know, if you see something yielding 15%…

That could be a red flag.

That’s a big red flag. But you know, to generate income in this environment, equities give you the opportunity not only to earn more than you might be able to earn in the bond market—either Treasuries or high-grade corporates—but also get that growth component. That growth component will be very important, I think, going forward.

Inflation really only has one direction to go. I don’t know how long it’s going to take, but at some point we’re going to stop hearing about deflation and we’re going to start hearing about inflation. Then is when you want to be the part owner of a business, not the creditor, the bondholder of a business.

So give me some picks now.

One of my most recent picks actually is General Electric (GE). It’s actually a stock I’ve owned for some time.

You’ve owned it?

I’ve owned it in our Dividend Builder model portfolio and personally as well.

In this case, I blew the original call. I bought the stock back in 2008, before they cut their dividend. If I’d known that was coming, if I’d understood how risky it was, there’s no way I would’ve wanted to deal with it.

But you compare now and then: back then, the company had a lot of potential problems in its financial-services unit. We were headed for the worst recession in more than 70 years. There were dramatic changes in the company’s balance sheet—much more liquidity, much, much less reliance on short-term debt, much more equity…padding, you know.

The rest of the business, the industrial businesses, are coming out of the recession. What do we see from that? The dividend is coming back. The dividend was cut dramatically down from 31 cents a share a quarter to just 10 cents. It was very painful. Now we are already back up to 15 cents, and I think the dividend goes up again at the end of this year.

Over the next two or three years, I think the dividend probably moves up another 50% from where we’re at now. You put that in play—now, we’re talking about a couple of years from now—instead of GE lately yielding in the high 3% range, it could be yielding almost 6% relative to what you can buy the stock for today.

Give me another pick.

Another one that’s a favorite of mine is a company called National Grid (NGG). It is one of the largest utilities in the world.

It operates utility systems that people in the northeastern United States would be familiar with, in Massachusetts, New York State, and such. But the real attractive aspect of the business is in the UK, where they’re the national operator of the transmissions systems for both electricity and natural gas.

In the United States, utilities and inflation don’t always get along, because you don’t necessarily get to charge more or earn a higher profit as a monopoly-utility operator just because inflation is going up.

In the UK, everything is indexed to inflation. As inflation picks up—if that turns out to be the case in the UK—they will automatically see increases in customers’ bills that will automatically flow to the bottom line. That makes for a great hedge against inflation.

The stock has been yielding around 6%, give or take. I really like that combination of an inflation hedge and that big income stream. Of course, it’s indexed to inflation in the UK, but for a long-term investor, you know, the difference between US and UK inflation and the currency rates, a lot of that is going to wash out.

I just, I really like the rate-making process in the UK, and I think that it’s perhaps more attractive than any of the US utilities that are similar right now.

Okay, so Josh, I know the ticker symbol for General Electric is GE. What is the ticker symbol for National Grid?

It’s NGG. It’s an American depositary receipt, but it actually pays a very consistent dividend, and there’s no withholding taxes like there are for a lot of foreign dividends because the company is in the UK.

And Josh, do you own National Grid personally or professionally?

Yes.

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