Utility stocks are stocks of companies that deliver essential services such as water, gas, and electricity among others. Utility stock is an ideal conservative option for investors looking for steady higher dividends. You can invest in utility stocks companies through a brokerage firm by buying individual utility stocks, mutual funds that are specialized in the utilities sector or as ETFs that include the select sector SPDR-utilities.
Utility companies provide the basic necessities to facilitate the running of the modern day life. The sector has well-built government oversight of the business practices because the companies provide the public services to the citizens.
Utility services are always in demand in any economy. The sector tends to be more stable in terms of its day to day performance. The utility stocks are less risky than most stocks in the market but a bit riskier than the bonds. Usually, the utilities pay above the market dividends.
Here are 5 reasons why you should buy utility stocks:
1. Most are monopolies and don’t have competition
Companies that provide the electricity and sewer systems require huge capital investments which could either be unpractical or undesirable to build multiple systems overlapping each other. It creates a huge barrier to new entries. There are thus only a few companies that enter into the business. This makes the business to have less competition and thus a perfect investment to power your portfolio.
2. The government set the rates and ensures a reasonable profit
The sector is highly regulated to ensure a balanced interest of shareholders and consumer needs. The customers’ needs are to have the utilities affordable to them but the business must make profits to remain afloat. To achieve this balance, the government sets the best rate that will help produce the desired revenues for the company or rather achieve reasonable profits for the company and provide the best rate of return for the investors.
3. They rarely go out of business
The clientele of the utilities is large as nearly all citizens and businesses use the utility companies’ services. Customers must pay their utility bills to continue using the services and to avoid cut-offs of the services. This means that the companies have consistent revenues and cash flows from the bill payments. The utility company is always guaranteed to remain in business unless they take on extremely risky ventures.
4. They get predictable cash flows that they rarely reduce their dividends
The utility companies’ profits and cash flows are large enough to allow the companies to increase their dividends on a constant basis. While investing in utility stocks, look for the dividend growth that increase consistently and that keep pace with the inflation rates. Invest in companies that have consistently increased their dividends in the last 4-5 years.
5. They pay steady dividends from their earnings
Since the companies expenses are well factored into the formula of determining the utility’s profits, the utility companies rarely reinvest their profits into the business. They use their entire earnings to pay out dividends to their investors. They pay up to 60-80% of their annual earnings to shareholders and the typical return on the shareholders' equity is 10-12%.
Utility stocks are some of the highest yielding stocks in the stock market and every investor should consider incorporating them into their portfolio.