Why You Should Have Utility Stocks in Your Portfolio

Utility stocks might seem dull on the face of it, but stability and dividends play a big role in driving shareholders’ total returns in the long term.

| More on:

Image source: Getty Images

Investors perceive utility stocks as boring and unrewarding. Certainly, why would one find them interesting when there are stocks that are doubling every year? Utilities are slow moving and do not have a jazzy business model. However, they offer some unique set of advantages that none of the other sectors offer.

Utility stocks: Stable dividends and slow-moving stocks

Utilities operate in a regulated environment and make a specific rate of return. That’s why they generate stable cash flows in almost all economic situations, facilitating stable payouts for shareholders. Thus, investors turn to relatively stable, recession-resilient utility stocks when the economic downturn looms.

Consider top utility stock Fortis (TSX:FTS)(NYSE:FTS). It makes a large portion of its earnings from regulated operations. Higher exposure to regulated operations enable earnings stability and visibility. That’s why Fortis has managed to increase dividends for the last 47 straight years. It yields close to 4%, higher than TSX stocks at large.

Utility companies give away a large chunk of their earnings to investors in the form of dividends. Fortis distributed almost 75% of its earnings as dividends. Interestingly, such a high payout ratio is not unusual for utilities.

Peer stock Canadian Utilities (TSX:CU) has an average payout ratio close to 80%. It also generates a majority of its cash flows from regulated operations. The stock yields 6%, way higher than TSX stocks. The yield premium against some high-quality bonds is what makes them attractive in a low-interest-rate environment.

Valuable in low-interest-rate environments

Normally, interest rates and utility stocks trade inversely to each other. Income-seeking investors move to utility stocks amid lower rates in search of higher yields. This further gives a push to utilities.

Additionally, due to their heavy capital requirements, utilities carry a large pile of debt on their books. So, lower rates decrease their debt servicing costs, ultimately improving their profitability.

Driven by stable dividends and fair capital growth, utility stocks have made a decent fortune for investors in the long term. Fortis has returned 13% compounded annually in the last 20 years, while Canadian Utilities stock has returned 10% compounded annually in the same period. That notably beat TSX Composite Index.

Another Canadian utility stock Emera (TSX:EMA) has also been a stable money grower for investors. It yields 5% at the moment. It has returned 11% compounded annually in the last two decades.

Low correlation with broader markets

Another critical advantage of utilities is their low correlation with broader markets. Utility stocks have a low correlation with broad market indexes than high-growth tech stocks.

When the volatility in broader markets increases, investors move to relatively firmer sectors in order to protect the principal. Thus, utilities are generally their preferred choice in uncertain times.

That’s why we may see broad market indexes fall 20% amid the recession fears, but utility stocks fall maybe just 10%.

Bottom line

Thus, diversification across sectors plays a significant role, and utilities should have at least some exposure in your long-term portfolio. Utilities might seem dull on the face of it, but stability and dividends play a big role in driving shareholders’ total returns in the long term.

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 Vineet Kulkarni has no position in any of the stocks mentioned. The Motley Fool recommends EMERA INCORPORATED and FORTIS INC.

More on Dividend Stocks

growing plant shoots on stacked coins
Dividend Stocks

4 Ways to Grow $100,000 Into $1 Million in Retirement Savings

Anyone can build a million-dollar retirement portfolio. Here are four ways you could practically grow $100,000 to $1 million.

Read more »

A shopper makes purchases from an online store.
Dividend Stocks

3 Reasons to Buy TFI Stock Like There’s No Tomorrow

TFI stock (TSX:TFII) had a hard 2023, but now it's set up for a solid 2024, with an acquisition that…

Read more »

Dividend Stocks

5 Secrets of TFSA Millionaires

These lesser-known secrets can help you set up the perfect long-term portfolio and achieve a million-dollar TFSA!

Read more »

analyze data
Dividend Stocks

How to Build a Powerful Passive-Income Portfolio With Just $20,000

These fundamentally strong TSX stocks have paid and increased their dividend in all market conditions. Add these stocks to build…

Read more »

Canadian stocks are rising
Dividend Stocks

iShares S&P/TSX Capped REIT Index ETF (TSX:XRE): Why I Like this ETF Better Than a Rental Property

XRE is a great ETF for gaining exposure to the Canadian real estate sector.

Read more »

Payday ringed on a calendar
Dividend Stocks

3 High-Yield Dividend Stocks That Pay Cash Every Month

These three dividend stocks all offer high yields and have sustainable dividends, making them some of the best investments to…

Read more »

Silver coins fall into a piggy bank.
Dividend Stocks

3 Stocks That Could Create Lasting Generational Wealth

If you want to start transferring over your wealth, you'll need to actually have some! And these are three stocks…

Read more »

data analytics, chart and graph icons with female hands typing on laptop in background
Dividend Stocks

Down by 25%: Is Canadian Tire Stock a Buy in February 2024?

Take a closer look at this Canadian retail stock if you are looking for low-cost additions to your self-directed portfolio…

Read more »