Bonds are Historically Expensive
I am stating the obvious when I say that there is a current aversion to US equities by the vast majority of investors. As a result, money is pouring in to bonds and bond funds. With interest rates hovering at all-time lows, we believe that the normal low risk profile of fixed income is potentially upside down today. In other words, we believe that bonds, especially bonds with longer duration, are as risky as they can ever get.
The 30-year treasury bond is offered at a yield of 3.55% and the 10-year treasury bond yields 2.5%. Historically speaking, this implies that bonds today are extremely expensive. More directly stated; the price of bonds today is very high. Therefore, if future interest rates rise dramatically, bond prices could also dramatically fall.
Historically, under more normal economic environments, the yields on 30-year treasury bonds would range between 6% and 8%. If you divide these normal yields into the price of bonds, then the normal price to yield would range between 12 1/2 times interest at 8% and approximately 16 1/2 times interest at a 6% rate.
Since the interest rate on a bond is fixed, this implies that even a no growth stream of income has a value that is a reasonable multiple of its yield. Consequently, 12 to 16 times yield is considered a historically normal and reasonable price to pay to buy a 30-year treasury bond.
If you divide today's yield of 3.55% into 100, or the price of the bond, you discover that 30-year treasury bonds are currently very expensive at over 28 times interest and the 10-year treasury bond is trading at over 39 times interest. This is significantly more expensive than a rational investor would historically expect to pay for a guaranteed income stream that doesn't grow.
Therefore, investors buying bonds today need to understand how expensive the instruments they are pouring their money into really are. At these prices, common sense would dictate that bonds are more expensive and therefore more risky today than they have been for a very long time.
Utility Stocks
It would be imprudent to state that equities, even conservative equities like utility stocks, would be considered safer than a treasury bond. On the other hand, based on the abnormally high rate risk that treasury bonds currently have, the safety gap is perhaps closer than it's ever been. As a result, prudent investors seeking income may want to take a closer look at select utility stocks as alternatives to bonds.
Therefore, this article presents five high-quality Eastern utility stocks that offer yields greater than the 30-year treasury bond. In addition, to the higher yield there is also an opportunity to receive modest growth of dividend income and possibly some capital appreciation.
Therefore, we have screened a select group of five Eastern utility stocks that appear worthy of further research. This report will not provide a thorough analysis of each selection; we leave that job to the interested reader. We will provide the reader with essential “fundamental research at-a-glance”, utilizing our EDMP F.A.S.T. Graphs.
We believe these powerful “tools to think with” provide a comprehensive view of important fundamentals organized to provide a valuable perspective. In short, the viewer receives a clear viewpoint of how well the business has been managed and the performance shareholders received as a result.
Selection Criteria
In order to compile this list of Eastern utility stocks we focused on stability and consistency regarding the dividend policy of each company. Since utility stocks are known for their slow growth, we didn't require a dividend increase every year, however, we did reject any company that cut their dividend even once since 1997. Additionally, since dividends are ultimately paid out of earnings, we looked for companies that generated earnings growth that was as consistent as possible with utility businesses.
Figures 1A and B through 5A and B look at five Eastern utility companies through the lens of our EDMP F.A.S.T. Graphs, with dividend yields higher than currently available on a 30-year treasury bond. Since three of these five choices have historical growth rates in excess of 5% they would be looked at based on our Graham Dodd modified EDMP formula for valuing a business.
These graphs will be marked on the right with an orange GDF-EDMP designation. Two of these five companies have growth rates less than 5% and therefore will be graphed based on Ben Graham's classic formula for valuing a business. These charts will be marked with an orange GDF designation to the right.
Figure 1A looks at NextEra Energy (NEE), formerly known as FPL Group, Inc. They serve as a holding company for their utility subsidiary Florida Power & Light. NextEra Energy Resources is a non-regulated power generator that owns wind, nuclear and gas energy generating properties.
(Click charts to enlarge)
Figure 1A NEE 15yr. EPS Growth Correlated to Price
Figure 1B calculates the performance associated with Figure 1A. Although NextEra Energy has the lowest current dividend yield of the five selections in this report at 3.8%, it is the only one that has increased their dividend every year since 1997. Additionally, NextEra Energy has the highest historical earnings per share growth rate at 6.9% of the group.
Figure 1B NEE 15yr. Performance History
Figure 2A NSTAR (NST) is a holding company that distributes electricity in Boston and approximately 80 surrounding towns and cities in eastern Massachusetts. They also own NSTR Gas that distributes to over 50 communities in central and eastern Massachusetts. As is clear from the graph, NSTAR has a very consistent historical record of modestly growing earnings each year.
Figure 2A NST 15yr. EPS Growth Correlated to Price
Figure 2B calculates the performance associated with Figure 1A. NSTAR maintained their dividend in 1997 and1998, but have raised in every year since. Also note the consistency of their payout ratio each year.
Figure 2B NST 15yr. Performance History
Figure 3A covers Dominion Resources, Inc. (D), which is the holding company for Virginia Power that serves customers in Virginia and northeastern North Carolina. Although their earnings growth has not been as consistent as some of the others on this list, it has been more consistent than most utilities.
Figure 3A D 15yr. EPS Growth Correlated to Price
Figure 3B calculates performance associated with Figure 3A. Even though Dominion Resources, Inc. did not raise their dividend every year, they were generous with their dividend when possible. Also note that Dominion Resources significantly outperformed the S&P 500 since 1997.
Figure 3B D 15yr. Performance History
Figure 4A graphs Southern Company (SO) which operates four subsidiaries that supply electricity to customers in Florida, Georgia, Alabama and Mississippi. Even though Southern Company has the lowest historical earnings growth rate of the group, it has also been one of the most consistent performers of the group. To compensate for the slower growth, their current yield of 5% is the highest of the five companies on this list.
Figure 4A SO 15yr. EPS Growth Correlated to Price
Figure 4B calculates the performance associated with Figure 4A. As seen in the dividend cash flow table, Southern Company has a decent record for a utility of increasing their dividend, even though the growth rate is very modest. Nevertheless, they outperformed the S&P 500 based on both total cash dividends paid and capital appreciation.
Figure 4B SO 15yr. Performance History
Figure 5A graphs Public Service Enterprise Group, Inc. (PEG), a holding company for Public Service Electric & Gas Company which serves electric and gas customers in New Jersey. PSEG Energy Holdings is a power producer both in the US and abroad.
Figure 5A PEG 15yr. EPS Growth Correlated to Price
Figure 5B calculates the performance associated with Figure 5A. Public Service Electric & Gas Company has consistently paid a dividend every year since 1997 and has increased their dividend each year since 2004.
Figure 5B PEG 15yr. Performance History 
Conclusions
Utility stocks have traditionally offered investors more yield than most typical dividend paying operating businesses. Since these are also businesses that have traditionally been regulated, utility stocks have also grown earnings at below-average rates. Even though many utility companies, including the ones reported on in this article, have been striving to diversify into less regulated businesses, the regulated portion remains a major and important contributor to their operating results.
Part of the purpose of this article was to illustrate that even though utility stocks offer higher yields than most equities, they leave much to be desired on a total return basis. Many strong operating companies grow at much faster rates, and therefore, even though their starting dividend yield may be lower, the growth rate of their dividend is much higher and more powerful.
Yield hungry investors today need to be conscious of this fact in order to make savvy and enlightened decisions about how to invest their money. Understanding that safety is a concern, there are many large-cap blue-chip stalwarts that can offer a much higher total return while giving up very little in safety or income.
That said, investors might want to consider a blended portfolio that provides both the opportunity for an income stream that is competitive with fixed income today, while simultaneously offering the opportunity for attractive capital appreciation and a growing dividend income stream. Equities such as utility stocks can be utilized to kick up the current yield of the portfolio, as long as it is recognized that some total return will be lost in the process.
Disclosure: Long NEE at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
