In the next week, I will be adding to my dividend growth portfolio. The overall portfolio yield is currently under my target goal of yielding 4.5% as outlined in my plan. As such, I am looking to add a safe utility with a higher yield to bump up its current yield of 3.5%. After reviewing my watch list, I've narrowed it down to two utilities to analyze, Duke Energy Corporation (NYSE: DUK) and Xcel Energy Inc. (NYSE:XEL). I will look at each company's financial strength, valuation, fundamentals and dividend history to determine which qualifies as the logical buy. For most research, I use Morningstar and S&P qualitative and quantitative stock reports. I also use Dave Fish's list of U.S. Dividend Champions found here.
Beginning with financial strength, both meet my plan's minimum standard of meeting a credit rating of BBB or higher from Morningstar. Both DUK and XEL have a credit rating of BBB+. This is important because quality companies are great for long-term growth, which is the aim of this portfolio.
S&P gives DUK a quality rating of B (Below Average) and XEL a B+ (Average). From this point, a good business metric to look at is a company's payout ratio. In other words, what percentage of earnings does a company payout to its shareholders? For smaller companies, the lower the better. The same goes for larger companies but the risk is inherently less if they are financially strong. DUK has a trailing twelve month payout ratio of 100.7% and XEL is 59.7%. I like XEL's ratio because anything under 70% has some space for dividend growth and they are a smaller company.
For valuation, S&P gives DUK a fair value rating of 2 (moderately overvalued). Morningstar recommends a purchase price of $75.00 with a rating of three stars (fairly valued). S&P also gives XEL a fair value rating of 2 and is overvalued approximately 2% more DUK. Morningstar recommends a purchase price of $29.00 with a rating of two stars (overvalued). This means that either way I will be paying a premium unless the price of either takes a drop in the next week.
Moving onto fundamentals, both have a beta of 0.26, which is low and typical for this sector. Utilities generally don't respond as much to fluctuations in the market as other sectors. Anything below 7 is great for my portfolio, according to my plan. DUK's P/E ratio is 23.2, which is above its historical average. XEL's P/E ratio is 16, which is a slightly higher than average. Its 10-yr historical P/E ceiling is 19.
For buy, sell, hold ratings, S&P analysts give DUK a rating of two stars, (hold rating) and XEL a rating of four stars (buy rating). One equity clearly has the edge after analysis so far, but we still need to look at the most important element of a dividend growth portfolio. Dividends and dividend growth.
As mentioned at the beginning of this article, the DGI plan sets an overall target dividend return of 4.5%. I don't purchase anything yielding below 2%. DUK's current yield is 4.41%, which would definitely push the portfolio closer to its target yield. XEL's current yield is 3.70, which is also good. But before I go chasing yield, I need to examine the stability and trends of their dividend growth rates.
I prefer to find DGR trends between the years. DUK's 5-yr DGR is 2.7 and its 3-yr DGR decreased to 2.0. This year, it has remained at 2.0. Although stable, it seems to have dropped and is remaining stagnant. XEL's 5-yr DGR is 3.3 and its 3-yr DGR increased slightly to 3.4. This year, it has grown to 3.8. It occurs relatively stable and increasing.
Lastly, an important metric to analyze is the Chowder Rule. Also known as the total dividend return rule, it is the sum of a company's yield and its 5-year dividend growth. For utilities, the sum of these two numbers should be 8 or higher. Unfortunately, both don't meet this minimum. DUK has a current chowder rule of 7.1 and 7.2. Although, with XEL's DGR trend, this might change in the near future.
To circle back, I started this article with two goals in mind; increasing the overall yield of my dividend growth portfolio and buying a safe, strong company. Although DUK would raise the overall yield, my overall analysis currently favors XEL. In the next week, I plan on opening a position.
Disclosure: The author is long XEL.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Although all figures are thought to be correct, no guarantee is expressed or implied.