If you’re thinking about buying utilities after the market’s recent run, you’re on the right track, as lowly-correlated dividend stocks can help dampen your downside to give you a market-beating edge in what’s starting to look like a risk-on year.
Now that yields are becoming scarce, with abysmal rates provided by risk-free debt instruments, the hunt for yield is getting harder, and the price of admission to many market darling utility stocks has gone up. While utility stocks can buoy your portfolio when the tides come in, you can still stand to get hurt if your entry point is too high. Valuation always matters, and there are no exceptions. If you end up overpaying for stock, you can still get hurt, even if you’re investing in the most stable utility out there.
This piece will have a look at two utility stocks that I still see as quite cheap given their sought-after bond-proxy traits. So, without further ado, consider Fortis (TSX:FTS)(NYSE:FTS) and Canadian Utilities (TSX:CU) if you want to get a good deal to a name that can act as shocks for your portfolio.
Fortis is the epitome of a bond proxy. And although the dividend, currently yielding 3.3%, isn’t as rich after its recent run, I still think the name could face further multiple expansion, as fixed-income investors throw in the towel on their bond investments and look to the more rewarding bond proxies like Fortis.
The company not only has one of the most stable cash flow streams as a result of its highly regulated operations, but it also has exceptional stewards that are driving Fortis to grow at a quicker rate than most other highly regulated utilities that lack exposure to the higher-growth U.S. market. Fortis has a growing foundation south of the border, and it’ll allow Fortis to nearly guarantee 5-6% in annual dividend hikes to its investors.
In an era of rock-bottom interest rates, it makes a heck of a lot more sense to invest in a utility with a 3.3% yield that can grow at a 5-6% rate for an indefinite period than a 2.5%-yielding short-term government bond or, goodness forbid, a long-term bond fund that’s arguably far riskier than a bond proxy that’s the calibre of Fortis.
Fortis stock isn’t cheap at this juncture at 11.4 times EV/EBITDA and 9.6 times cash flow, but it’s certainly not expensive given the environment we’re in. I say buy Fortis and just forget about it. It’s a premier utility stock that’s hard to beat.
If you’re in the market for an even cheaper utility stock with a larger dividend yield, Canadian Utilities (TSX:CU) may be better suited for your portfolio.
The stock currently sports a 4.1% dividend yield and is on the verge of breaking out past its $41-42 long-term ceiling of resistance. If you’re a technician, there’s no doubt that Canadian Utilities looks to be a more timely stock at this juncture, and if you’re all about the fundamentals, the stock is also too good to pass on in the low $40 range.
At the time of writing, CU stock trades at a mere 9.8 times EV/EBITDA and 8.6 times cash flow. And with one of the longest dividend-growth streaks in Canada (currently at 48 years), Canadian Utilities is within two years of entering the exclusive Dividend King club, making the name a more rewarding and an arguably “safer” bet than any “risk-free” investment out there.
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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Joey Frenette owns shares of FORTIS INC.