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I have been a dividend growth investor for over eight years now. Over those years, I have slowly allocated a diverse portfolio that is spread out among the major sectors, except for one. I have yet to invest in any utility stocks. Now this may come as a shock to other dividend growth investors as utility stocks have been a cornerstone for many dividend portfolios.

Utility stocks have a long history of paying dividends to their shareholders. This is because what they provide (electricity, water, gas) are always in need, despite what the economy is doing. These stocks tend to have stable, predictable, and secure cash flows. And their stocks are typically less volatile vs. the overall market (low beta).

The problem I have had is finding the right utility stock to buy at the right time. I have felt for some time now that the utility sector has been overvalued. During a time of high market volatility and low interest rates, it's no wonder investors have sought refuge in utilities' steady performance and higher dividend payouts. That attraction has caused inflated valuations and lower dividend yields, though -- two things a dividend growth investor does not like.

After watching utilities make their climb for the past three years, I was beginning to think I had missed my opportunity, but a recent pullback in the sector may have opened up a buying window. My focus is not just on current yield and valuation, but also on the company's ability to increase its dividend in the future. In my search, I focused on the following criteria:

  • Consecutive years of dividend growth:
    I want to see a past history of growth that has lasted at least through the recent recession
  • 5 year dividend growth rate:
    Dividend growth should at least keep up with normal inflation (3%)
  • Dividend payout ratio
    If this is too high, future dividend increases could be at risk
  • Debt to Total Capital
    If this is too high, future dividend increases could be at risk
  • Current yield vs. 5 year average yield
    Is the current valuation (based on yield) higher or lower than the past.

Below are several utility companies I researched using the above criteria. The numbers presented came from www.dividendinvestor.com.

Southern Company (NYSE:SO) is an Atlanta-based energy holding company that is one of the largest producers of electricity in the U.S.

Consecutive Dividend Raises

10 Years

5 Year Dividend Growth Rate

4%

Dividend Payout Ratio

77%

Debt to Total Capital

53%

Current Yield vs. 5 Year Avg

4.4% vs. 4.6%

Dominion Resources, Inc. (NYSE:D) includes regulated electric transmission and distribution operations that serve residential, commercial, industrial, and governmental customers in Virginia and North Carolina.

Consecutive Dividend Raises

8 Years

5 Year Dividend Growth Rate

7.6%

Dividend Payout Ratio

104%

Debt to Total Capital

64%

Current Yield vs. 5 Year Avg

4.1% vs 4.3%

NextEra Energy, Inc. (NYSE:NEE) is the holding company for Florida Power & Light and NextEra Energy Resources.

Consecutive Dividend Raises

16 Years

5 Year Dividend Growth Rate

8%

Dividend Payout Ratio

47%

Debt to Total Capital

62%

Current Yield vs. 5 Year Avg

3.5% vs 3.7%

PPL Corporation (NYSE:PPL) engages in the generation, transmission, distribution, and sale of electricity to wholesale and retail customers in the United States and the United Kingdom.

Consecutive Dividend Raises

12 Years

5 Year Dividend Growth Rate

3.8%

Dividend Payout Ratio

51%

Debt to Total Capital

64%

Current Yield vs. 5 Year Avg

5.0% vs 4.8%

Consolidated Edison Inc. (NYSE:ED) is an electric and gas utility holding company that serves parts of New York, New Jersey and Pennsylvania.

Consecutive Dividend Raises

37 Years

5 Year Dividend Growth Rate

1%

Dividend Payout Ratio

64%

Debt to Total Capital

48%

Current Yield vs. 5 Year Avg

4.3% vs 4.9%

Xcel Energy Inc. (NYSE:XEL) engages in the generation, purchase, transmission, distribution, and sale of electricity in the United States.

Consecutive Dividend Raises

8 Years

5 Year Dividend Growth Rate

3%

Dividend Payout Ratio

57%

Debt to Total Capital

56%

Current Yield vs. 5 Year Avg

3.9% vs 4.4%

UNS Energy (NYSE:UNS), through Tucson Electric Power Co., provides regulated electric service to over 403,000 retail customers in southeastern Arizona.

Consecutive Dividend Raises

11 Years

5 Year Dividend Growth Rate

15%

Dividend Payout Ratio

76%

Debt to Total Capital

58%

Current Yield vs. 5 Year Avg

4% vs 4.1%

Conclusion

Consolidated Edison is the clear standout for consecutive dividend raises, but its meager 5 year dividend growth rate of 1% is disappointing. Dominion's dividend growth comes in at a respectable 7.6%. Its dividend payout ratio above 100% is disconcerting, though. It has also reported negative free cash flow for the past seven years. Xcel's dividend payout ratio and debt to total capital are currently below 60%, which shows the company should have no problem increasing its dividend in the future. The dividend growth rate of 3% is in-line with historical inflation, but I'd prefer to see it higher. PPL is currently sporting the highest yield of this group at 5%. It is also the only one whose current yield is higher than its 5 year average yield, which suggests the current valuation may be favorable. Its dividend growth rate is on the lower side, but still just above inflation at 3.8%. Southern also has a dividend growth rate around the 4% level, and a higher current dividend yield of 4.5%. NextEra has a longer history of dividend increases, solid dividend growth, and favorable dividend payout ratio and debt to total capital. Its current yield is the lowest of the group though, at 3.5%. Finally, UNS is the clear winner in average dividend growth at 15%. Its dividend payout ratio is on the higher side, but still reasonable for a utility stock.

Based on the information above, I intend to take a deeper look at PPL, Southern, NextEra and UNS. Although PPL and Southern have lower dividend growth rates, their current yields offset the slower growth in the near term. NextEra and UNS have demonstrated stronger dividend growth numbers, so I would expect the current yields to grow more quickly in the near term.

With an upcoming potential dividend tax increase in 2013, I will likely wait until after the new year to make a purchase in the utility sector. I am hoping a sell-off occurs in the sector due to this potential new tax, thus creating a more favorable entry point. I hope to initiate this position in my Roth IRA so I can bypass the potential new tax.

Source: Searching For A Dividend Growth Utility Stock