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Utility stocks are among the top dividend payers in the market. While many investors discard utility stocks as boring investments, some companies in this sector returned outstanding profits to shareholders. In the last 15 years, Southern Company’s (NYSE:SO) and Dominion Resources’ (NYSE:D) shareholders enjoyed annual returns of 10.56% and 9.36%, respectively. In the same period, the S&P 500’s (NYSEARCA:SPY) annual return was only 6.97%. Performance of utility companies is mostly compared with long-term government and corporate bonds. Therefore, I decided to go back to 15 years and compare a diversified portfolio of 11 large-cap utility companies with that of bonds. I downloaded the dividend-adjusted data on utility stocks from Yahoo Finance. The data on Treasury Bills and Moody’s Seasoned Corporate Bond Yields is derived from the Federal Reserve Bank of St. Louis. Here is what I found:

Click to enlarge


As one can see from the graph above, even the worst performing utility stock’s return was more or less in line with the bond returns. The following table shows the relative performance of $1,000 invested in utility companies or bonds:

Name

Ticker

1995

2011

Southern Company

SO

$1,000

$9,762

Exelon Corp.

EXC

$1,000

$6,223

Dominion Resources

D

$1,000

$8,298

Duke Energy

DUK

$1,000

$3,378

Next Era

NEE

$1,000

$5,749

American Electric

AEP

$1,000

$2,571

PG & E Corp.

PCG

$1,000

$4,148

PPL Corp.

PPL

$1,000

$6,173

Consolidated Edison

ED

$1,000

$4,751

Progress Energy

PGN

$1,000

$4,062

Edison International

EIX

$1,000

$3,973

Average

Utility

$1,000

$5,372

Corporate BAA Bond

BAABond

$1,000

$3,278

Corporate AAA Bond

AAABond

$1,000

$2,790

Treasure Bond

10YTreasury

$1,000

$2,209

So, $1,000 invested in Southern Company in 1995 is worth $9,762 (including reinvested dividends) in 2011. Dominion, another outperformer, gained more than 700% in the last 15 years. Even the worst performers, Duke Energy and American Electric, returned better than government bonds. A diversified portfolio of 11 utility companies returned a cumulative average of 437% in the last 15 years. The relatively riskier corporate BAA bonds returned 228% in the same period. Here is a visual summary of the diversified utility portfolio vs. bond returns:

Click to enlarge

One might wonder whether the results can be extended to longer periods of time. I checked the average returns for the last 25 years to see whether the utilities also outperformed bonds during this period. Here is the performance of $1000 invested in 1985:

Utility

10YTreasury

BAABond

AAABond

1985

$1,000

$1,010

$1,011

$1,010

2011

$45,049

$4,814

$8,679

$6,691

Between 1985 and 1995, the U.S. economy experienced a highly inflationary period, where inflation was a serious problem. In November 1990, inflation hit its local peak value of 6.3% (it has never reached that value since then). Extending my analysis to that period significantly improved the divergent-superior performance of utility companies. The following graph makes it easier to see the results:

Click to enlarge

In summary, $1,000 invested in a diversified portfolio of utility stocks in 1985 is now worth $45,000. The same investment in long-term government bonds is worth only $4,814. Even the performance of relatively riskier Corporate BAA Bonds is no match for the utility stocks.

Investors, holding treasury bills or corporate bonds, should seriously consider dumping them and buying utility stocks instead. Surely, the performance of any stock is subject to short-term volatility. There is always the possibility of capital loss in the stock market. Nevertheless, the power of mean reversion can produce highly superior returns for long-term investors. That is why dividend paying utility companies with positive growth expectations is among the best investments for the long-term.

Seeking Alpha reader Brad Hobbs suggested article idea.

Source: Don't Buy Bonds, Buy Utility Stocks