A lot of people come into the stock market to make a quick buck. And that’s why growth stocks steal the limelight, and slow-moving, stable utility stocks are left on the sidelines. However, it is the stability and not growth that matters a lot when you are investing for the long term.
Why utility stocks?
Very few businesses stand tall in recessions. Utilities are one of them. We are going to use electricity in booming as well in failing markets. As a result, utility companies earn stable cash flows in almost all economic scenarios, creating stable wealth for shareholders. However, high-growth tech stocks or mining companies take severe beatings in bear markets, because their earnings are more aligned with economic cycles.
For example, top Canadian utility Fortis (TSX:FTS)(NYSE:FTS) has been a solid outperformer in the long term. It has returned more than 1,200% since 2001, notably outperforming TSX stocks at large. It managed to grow its earnings slowly but steadily all these years, standing tall through multiple financial crises.
Peer Algonquin Power & Utilities (TSX:AQN)(NYSE:AQN) came a little later but did even better. It is a relatively faster-growing utility. It returned 500% in the last decade, driven by its superior earnings growth and large renewable operations.
Superior dividend yields
Algonquin stock currently pays a juicy dividend yield of 4.5%, while Fortis yields 3.5%. In addition, utilities’ stable earnings enable stable dividend payments, which substantially increases total returns in the long term.
Also, utilities are some of the generous companies in the broader markets when it comes to shareholder payouts. They give away almost 60-70% of their net income in the form of dividends to shareholders. Fortis paid 67% of its income last year as dividends.
Long dividend increase streaks are not unusual among utilities. Better predictability about their cash flows facilitates dividend payments. For example, Fortis has increased its dividends for the last 47 consecutive years, while Algonquin has increased payouts for more than a decade. However, Canadian Utilities wears the crown of Canada’s longest dividend-increase streak with 49 consecutive years.
Interest rates and utility stocks generally trade inversely to each other. As a result, market participants turn to these defensives in search of superior yields when central banks start lowering rates.
However, rates are already at record lows at the moment. The U.S. Fed intends to start raising rates in 2023. Interestingly, a slower pace of interest rate hikes and premium yields could cushion the weakness of utility stocks. The Fed increased rates during 2015 and 2020, and utility stocks on average returned fairly decent 60% during the period.
Apart from superior yields, utility stocks’ slow movements act as a hedge in volatile markets. That’s why investors take shelter in utilities to protect capital amid uncertain broader markets.
Although utilities might sound boring, they can generate decent returns over a long period. Moreover, the risk/reward proposition becomes highly attractive because of their resilience to recessions and stable dividends.
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.
The Motley Fool recommends FORTIS INC. Fool contributor Vineet Kulkarni has no position in any of the stocks mentioned.