Broader markets will likely be more volatile this year amid the bumpy economic recovery. Long-term investors can consider utility stocks to gain in these times of market uncertainty.
Why utility stocks?
While utility stocks are perceived as boring, they offer some rewards that none of the other sectors do. Regular dividends and slow-moving stocks are some of the benefits that are highly useful in these kinds of markets. They provide unmatchable portfolio stability along with decent total return potential.
Such a long dividend-payment streak is not unusual among utilities, mainly because of their stable earnings. Utilities operate in a regulated environment and generate a stable rate of return. Irrespective of the broader economy, utilities like Fortis generate stable cash flows, enabling stable dividend payments.
Top TSX utility stocks
Consider a peer utility Algonquin Power & Utilities (TSX:AQN)(NYSE:AQN). The stock has created massive wealth for its shareholders, returning almost 22% compounded annually in the past decade. If you invested $10,000 in AQN stock back in 2011, you would have accumulated $72,000 today.
That’s a way superior growth for utility stocks at large. Algonquin managed a steep earnings growth in this period driven by its large renewable operations, which made such a feat possible.
Notably, the macroeconomic environment is also immensely supportive for utilities this year. Interest rates worldwide are to remain at record lows for the next few years. Investors should note that rates and utility stocks generally trade inversely. Yield-seeking investors shift to utility stocks amid lower interest rates in search of higher passive income. This further boosts utility stocks.
Algonquin Power and Fortis currently yield almost 4% each. They should continue to pay regular dividends for the next several years. Importantly, both aim to increase dividends by around 5-7% annually for the future. That’s a decent growth to beat inflation. Additionally, the projected dividend growth highlights the management’s confidence in the company’s future earnings.
Utilities pay a big portion of their earnings in the form of dividends to shareholders. Thus, they have higher payout ratios as well.
Indeed, utilities don’t have a glamorous business model, nor they offer sky-high growth. However, you won’t see wild stock price swings with utilities, which gives investors immense comfort.
Because of the stable dividends, investors turn to utilities when markets turn ugly. That’s why utility stocks have a lower correlation with broader markets, and they outperform during stressed times. In the 2008 financial crisis, utility stocks remarkably outdid growth stocks and even the S&P 500.
Thus, even if you are an aggressive investor and possess a knack for picking out growth stocks, you should allocate a portion to utilities. It will not only give portfolio stability but will also rake in a decent passive income for life.
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Fool contributor Vineet Kulkarni has no position in any of the stocks mentioned. The Motley Fool recommends FORTIS INC.