The Best Electric Utilities for Diversification

|
 |  Includes: AEP, AT, CEG, CNP, D, DTE, DUK, ED, EIX, ES, ETR, EXC, FE, NEE, PCG, PEG, POR, PPL, SO, SPY, TE, WEC, XEL, XLU
by: Bennington Investment Ideas

Utilities have always been attractive given their high yields and relatively low correlations to the market. Furthermore, utilities have provided consistent growth and reliable dividends over the years. In today's low interest rate environment, investors look more to dividend stocks for current income given the anemic yields on other financial products like money market accounts, CDs and even bonds.

However, utility stocks do put more on an investor's capital at risk than these other options. Due to this, it is worthwhile to look for utility stocks that also provide some diversification benefits as well. I will limit this article to the following utilities:

Select Electric Utilities

Ticker Name Last Close (August 19th) Market Cap ($ Billions) Div. Yield %
SPY SPDR S&P 500 Trust ETF 112.64 NA 2.2
XLU SPDR Select Sector Fund - Utilities 32.39 NA 4.0
SO Southern Company (The) 39.97 33.9 4.7
EXC Exelon Corporation 41.75 27.7 5.0
D Dominion Resources, Inc. 47.99 27.6 4.1
DUK Duke Energy Corporation 18.24 24.3 5.5
NEE NextEra Energy, Inc. 54.29 22.9 4.1
AEP American Electric Power Company, Inc. 37.06 17.9 5.0
FE FirstEnergy Corporation 41.75 17.5 5.3
PCG Pacific Gas & Electric Co. 41.19 16.4 4.4
PEG Public Service Enterprise Group Incorporated 31.62 16.0 4.3
ED Consolidated Edison Company of New York, Inc. 54.36 15.9 4.4
PPL PPL Corporation 27.3 15.8 5.1
PGN Progress Energy Inc. 46.49 13.7 5.3
EIX Edison International 35.86 11.7 3.6
XEL Xcel Energy Inc. 23.31 11.3 4.5
ETR Entergy Corporation 61.88 11.0 5.4
DTE DTE Energy Company 47.51 8.0 5.0
CNP CenterPoint Energy, Inc (Holding Co) 18.73 8.0 4.2
CEG Constellation Energy Group, Inc. 36.74 7.4 2.6
WEC Wisconsin Energy Corporation 30.16 7.0 3.5
NU Northeast Utilities 32.22 5.7 3.4
TE TECO Energy, Inc. 17.15 3.7 5.0
POR Portland General Electric Company 22.55 1.7 4.7
AT Atlantic Power Corporation 14.25 1.0 7.7
Click to enlarge

Source: data provided by Zacks.com premium services, Yahoo!Finance, and author calculations.

The analysis will focus on which of these utilities provide the lowest correlation to the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) and also adjust for which ones have the highest dividend yields. This article will not consider valuation aspects of these companies. It should also be noted that some utilities are regulated, some are deregulated, and some provide both regulated and deregulated services. EXC is one example with both regulated and unregulated divisions with Commonwealth Edison in Chicago and PECO in Philadelphia. DUK and PGN should have the same correlation since the two are currently seeking a merger where each share of PGN will be converted to approximately 2.6125 shares of DUK. EXC has also announced that it will acquire CEG.

The following table shows the 36 month correlations and volatilities between these utilities and SPY:

Correlations to SPY

Ticker Correlation 36 months Volatility 36 months Ratio to SPY
SPY 100% 6.2% 100%
EIX 73% 5.3% 85%
POR 71% 6.0% 97%
TE 67% 8.1% 130%
D 66% 5.0% 81%
DTE 65% 6.0% 97%
EXC 65% 4.9% 79%
NU 64% 4.4% 71%
DUK 64% 3.5% 57%
XLU 72% 4.3% 79%
NEE 59% 5.1% 82%
ETR 58% 5.7% 91%
PGN 58% 3.7% 59%
AEP 55% 5.2% 84%
CNP 54% 7.2% 117%
XEL 53% 4.4% 72%
CEG 53% 8.3% 133%
PPL 48% 5.6% 91%
SO 42% 4.1% 65%
FE 42% 7.8% 126%
WEC 41% 4.0% 64%
PCG 35% 3.4% 55%
ED 26% 4.1% 65%
Click to enlarge

Source:derived from Yahoo!Finance monthly split and dividend adjusted prices.

The first observation is that volatility and correlation are unrelated, which one would expect. EIX, TE and POR all showed very high correlations, while ED, PCG, and WEC all had very low correlations. These last three stocks also had very low volatilities which suggests that they would provide the most diversification benefit to an SPY portfolio. It is a simple step to calculate the volatility of a portfolio composed of two securities when there correlation coefficient and individual volatilities are known.

The following table ranks the stocks based upon the lowest volatility for a portfolio that is 50% SPY and 50% of each of the tickers, including XLU.

Portfolio Volatility

Ticker Volatility of 50% SPY 50% ticker portfolio
XLU 4.9%
TE 6.5%
CEG 6.4%
SPY 6.2%
FE 5.9%
CNP 5.9%
POR 5.7%
DTE 5.6%
EIX 5.4%
ETR 5.3%
D 5.1%
PPL 5.1%
EXC 5.1%
NEE 5.0%
AEP 5.0%
NU 4.8%
XEL 4.7%
DUK 4.4%
PGN 4.4%
SO 4.4%
WEC 4.3%
ED 4.1%
PCG 4.0%
Click to enlarge

Source: Author Calculations

The portfolios with TE and CEG have higher volatilities than just SPY due to their high volatility and relatively high correlations. As expected, the three best utility stocks for diversification benefits are ED, WEC, and PCG, which was the best overall stock. SO and PGN also performed well by this measure. PGN should be interesting given that it also has the highest dividend yield among the top 5 stocks for diversification.

Disclosure: I am long SPY.

Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.