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Many people buy utility stocks as defensive plays. They are stable companies, often having no competition in the region they serve, and can offer secure earnings, with predictable rate increases that are guaranteed (controlled) by the government. They usually pay a nice dividend, with a good yield, but a relatively low dividend growth rate (DGR). But in return for the stability and good yield of the utilities the investors are willing to sacrifice total return. I don't think many people expect to "beat the market" by buying utilities. They look to collect nice dividends, with relatively low capital appreciation during bull markets while minimizing losses during bear markets. Although they certainly want the value of their portfolio to grow, they are willing to give up some total return in exchange for the safety of their investments. OK, perhaps I am making assumption about other investors, but that is how I always thought of utilities.

But is this necessarily the case? Can you have your cake and eat it too? Can you actually achieve market beating returns just by investing in safe, boring utilities? Previously I did a study showing that a stock with a good yield, a dividend that grows every year (even at a relatively slow rate) and that has all the dividends reinvested, would achieve excellent results, even if it was a slow growing stock like a utility. But that was just a "model" stock. Could it actually work in real life examples? I thought it would. I thought that if the utility stock has a good yield, raises its dividend every year, and you reinvest all those dividends, then on both an income basis and a total return basis the stock would perform very well. And I did a study to examine this question.

For this back test study I looked for utility stocks that had been raising their dividend for at least ten years in a row, and I followed them for the next ten years, to see how they performed. I took David Fish's most recent CCC list (May 2013) and looked for utility stocks that had been raising their dividend every year for at least the past 20 years. That would mean that when the back test period started, in January of 2003, they would already have been increasing their dividend for 10 years. In other words, each one of these stocks had been raising their dividend, every year from at least 1993 through 2003. Using price and dividend data from Yahoo.com I followed these stocks from January 2003 up until June 2013, reinvesting all dividends, to see how they performed.

The utility stocks which in Jan 2003 had raised their dividend for at least 10 years in a row were Atmos Energy Corp (ATO), American States Water Co. (AWR), Black Hills Corp (BKH), Connecticut Water Services (CTWS), California Water Services (CWT), Con Ed (ED), Energen (EGN), MDU Resources Group (MDU), MGE Energy (MGEE), Middlesex Water Co. (MSEX), National Fuel Gas Co. (NFG), Northwest Natural Gas Co. (NWN), Piedmont Natural Gas Co. (PNY), SJW Corp (SJW), UGI Corp (UGI), Vectren Corp. (VVC), WGL Holdings (WGL), Aqua America Inc. (WTR).

$10,000 worth of each of these stocks was purchased (to the closest whole share) in Jan 2003, all dividends were reinvested on the ex-dividend day (as per Yahoo.com) and the stocks were held through June of 2013. Here are the results for each stock, as well as the return for SPY with all dividends reinvested (to be used as the "Market return"):

RETURNS

Stocks

Ending Value

Annual Return

Start Yield

End Yield

ATO

$26,526.17

9.79%

5.44%

3.14%

AWR

$31,212.29

11.51%

4.06%

2.61%

BKH

$26,654.61

9.85%

5.28%

3.05%

CTWS

$16,574.83

4.96%

3.24%

3.41%

CWT

$22,892.33

8.24%

4.65%

3.18%

ED

$21,768.73

7.72%

5.71%

4.00%

EGN

$41,110.14

14.47%

2.48%

1.11%

MDU

$27,929.67

10.32%

3.56%

2.74%

MGEE

$29,055.95

10.74%

5.23%

2.96%

MSEX

$17,881.94

5.72%

3.78%

3.83%

NFG

$38,501.49

13.75%

4.78%

2.38%

NWN

$22,823.11

8.21%

4.84%

4.11%

PNY

$26,963.20

9.95%

2.32%

3.75%

SJW

$25,189.24

9.29%

3.64%

2.83%

UGI

$40,433.87

14.32%

4.14%

2.90%

VVC

$23,163.67

8.38%

5.49%

3.94%

WGL

$27,190.30

10.05%

5.16%

3.83%

WTR

$30,190.75

11.14%

2.58%

2.14%

SPY

$21,337.78

7.56%

1.58%

2.11%

Of the 18 boring, defensive utility stocks in the study 16 of them beat the market for total return over the ten year period. Note that this is a time period in which the S&P had a strong recovery from a steep recession, went through a second steep recession, and then recovered again, reaching new highs. It went through 3 distinct phases, including two strong recoveries, so any stock that performed better then SPY during this time period would be very impressive. And 89% of these utility stocks did just that.

As a dividend growth investor my main goal is a stream of dividend income that increases year after year. If one were to make a portfolio out of the above utility stocks the income would have been as follows. It is compared to a portfolio were all the capital was invested in "The Market" (SPY).

INCOME

Year

Income

Yearly Change

SPY

Yearly Change

2003

$7,194.18

$3,231.53

2004

$7,999.11

11.19%

$4,432.59

37.17%

2005

$8,780.57

9.77%

$4,414.33

-0.41%

2006

$9,401.06

7.07%

$5,115.04

15.87%

2007

$9,924.77

5.57%

$5,751.95

12.45%

2008

$10,758.44

8.40%

$5,906.34

2.68%

2009

$11,501.39

6.91%

$4,846.71

-17.94%

2010

$12,417.91

7.97%

$5,151.25

6.28%

2011

$13,295.50

7.07%

$5,972.03

15.93%

2012

$14,218.65

6.94%

$7,348.84

23.05%

Total

$105,491.58

$52,170.62

I did not include income for 2013 since it has only been half a year's worth of dividends.

Even through the financial meltdown a portfolio of these stocks continued to raise its dividend income by 5-8% per year. And the total amount of dividends collected (and reinvested) for the ten year period was twice as much from the utility portfolio as if you put all your funds into "the market".

I understand that by using the most recent CCC list to pick the stocks for the study that there will be survivorship bias, and that I may not have included all the utility stocks that up until January 2003 had been increasing their dividend for 10 straight years. Some utilities may have cut their dividend in the past ten years, and therefore are no longer found on the CCC list. But, as far as I know, a real time list from 2003 is not available to me. So I used what I could. Secondly, the point of this article is not to show that ALL utility stocks will beat the market if their dividends are reinvested, but to show that many can.

Conclusion

By buying utilities with a good starting yield and a strong history of dividend growth, by insuring that they continue to raise their dividend every year (by removing any utilities from your portfolio that don't), and by reinvesting all dividends, there is a good chance that even by buying boring utility stocks you will still be able to "Beat the Market" while still enjoying their safety.

Thank you for reading my article.

Source: How To Get Excellent Returns With Utility Stocks

Additional disclosure: I am not an investment advisor. Nothing I write should be considered to be a recommendation to buy any particular stock. I am simply discussing and explaining the methods I use and some studies I have done. Every investor should do their own due diligence.