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Many dividend investors seek out utility stocks to provide current income with a relatively stable stock. One quick way to achieve this type of exposure is through SPDR Select Sector Funds - in this case the Utilities ETF (NYSEARCA:XLU), which focuses on electric utilities. Its largest holdings include The Southern Company (NYSE: SO), Exelon Corporation (NYSE: EXC) and Duke Energy Corporation (NYSE: DUK).

XLU offers an approximate 4.1% dividend yield based on the most recent data. XLU also has a relatively low volatility at 4.3% when compared to the broader market as measured by the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) which is at 6.2% with just a 2.2% dividend yield based on a recent price of $112.64. XLU also shows a 72% correlation to SPY. The goal of this article will be to look for individual electric utility stocks that would provide an improved dividend yield and lower volatility when added to the base portfolio of XLU. A utility dividend investor should be interested in these types of stocks assuming that their future prospects and valuations are reasonable. This article will look at a select group of electric utility stocks, selected for relatively high dividend yields as well as reasonably large market capitalizations.

Select Electric Utilities
TickerNameAugust 19th CloseMarket Cap ($ Billions)Div. Yield %
SOSouthern Company (The)39.9733.94.7
EXCExelon Corporation41.7527.75.0
DDominion Resources, Inc.47.9927.64.1
DUKDuke Energy Corporation18.2424.35.5
NEENextEra Energy, Inc.54.2922.94.1
AEPAmerican Electric Power Company, Inc.37.0617.95.0
FEFirstEnergy Corporation41.7517.55.3
PCGPacific Gas & Electric Co.41.1916.44.4
EDConsolidated Edison Company of New York, Inc.54.3615.94.4
PPLPPL Corporation27.315.85.1
PGNProgress Energy Inc.46.4913.75.3
EIXEdison International35.8611.73.6
XELXcel Energy Inc.23.3111.34.5
ETREntergy Corporation61.8811.05.4
DTEDTE Energy Company47.518.05.0
CNPCenterPoint Energy, Inc (Holding Co)18.738.04.2
CEGConstellation Energy Group, Inc.36.747.42.6
WECWisconsin Energy Corporation30.167.03.5
NUNortheast Utilities32.225.73.4
TETECO Energy, Inc.17.153.75.0
PORPortland General Electric Company22.551.74.7

Source: Data provided by Zacks.com premium services.

The first step of this process is to compute the correlations and relative volatilities between the individual stocks and XLU. This data is shown in the following table.

Correlation to XLU
TickerCorrelation to XLU 36 monthsVolatility 36 monthsRatio
XLU100%4.3%100%
EXC90%4.9%116%
TE88%8.1%189%
D87%5.0%118%
CNP86%7.2%170%
EIX83%5.3%124%
PGN83%3.7%86%
DTE81%6.0%141%
NU81%4.4%104%
ETR80%5.7%133%
NEE78%5.1%119%
DUK76%3.5%83%
XEL74%4.4%104%
SPY72%6.2%145%
AEP72%5.2%122%
FE72%7.8%184%
WEC72%4.0%93%
SO71%4.1%95%
PPL71%5.6%132%
POR70%6.0%142%
PCG62%3.4%81%
CEG62%8.3%194%
ED45%4.1%95%

Source: Derived from data from Yahoo!Finance.

Many of these stocks have dividend yields above 4.1% which means that the combined portfolio will improve. The following table shows the revised yield of a portfolio with 50% XLU and 50% of the selected stocks.

New Portfolio Yield
TickerNew Yield (%)Yield Improvement (%)
DUK4.8 0.70
ETR4.7 0.64
PGN4.7 0.62
FE4.7 0.59
PPL4.6 0.52
EXC4.6 0.47
TE4.6 0.46
AEP4.5 0.44
DTE4.5 0.43
SO4.4 0.32
POR4.4 0.31
XEL4.3 0.19
PCG4.3 0.17
ED4.3 0.17
CNP4.2 0.06
D4.1 0.01
XLU4.1 -
NEE4.1 (0.02)
EIX3.8 (0.26)
WEC3.8 (0.32)
NU3.8 (0.34)
CEG3.4 (0.74)
SPY3.1 (0.97)

Source: Author Calculations

This table shows quite clearly that most of the selected utilities provide higher yields than XLU. However, stocks like EIX might still be valuable. Even if EIX does not improve the yield, if it provides substantial volatility reduction, it might be a valued addition to the portfolio.

Right now it appears that DUK is a good option. However, conversely to EIX, if DUK substantially increases portfolio volatility, then it might not be a good addition. The following table shows the impact on volatility ranked by the ratio of yield to volatility. XLU has a ratio of 96% meaning that its yield is 96% of its volatility.

Portfolios with ratios above this most likely provided improved portfolio volatility at higher yields. Portfolios at the bottom provided lower yields with higher volatility ( a double negative). The interesting mix are stocks that increased volatility by a little but had a substantial impact on yields, resulting in a net improvement.

Ratio of Yield to Volatility
TickerVolatility of 50% XLU 50% ticker portfolioVolatility deltaYield Delta (%)Ratio of Portfolio Yield to Vol
DUK3.7%-0.6% 0.70 130%
PGN3.8%-0.5% 0.62 124%
PCG3.5%-0.8% 0.17 122%
ED3.5%-0.7% 0.17 120%
SO3.8%-0.4% 0.32 115%
XEL4.1%-0.2% 0.19 105%
AEP4.4%0.1% 0.44 103%
EXC4.5%0.2% 0.47 102%
PPL4.6%0.3% 0.52 101%
ETR4.7%0.5% 0.64 100%
WEC3.8%-0.5% (0.32)99%
XLU4.3%0.0% - 96%
POR4.8%0.5% 0.31 92%
NEE4.4%0.1% (0.02)92%
DTE4.9%0.6% 0.43 92%
D4.5%0.2% 0.01 91%
NU4.1%-0.1% (0.34)91%
EIX4.6%0.3% (0.26)84%
FE5.7%1.4% 0.59 83%
TE6.0%1.7% 0.46 76%
CNP5.6%1.3% 0.06 75%
SPY4.9%0.6% (0.97)64%
CEG5.7%1.4% (0.74)59%

Source: Author calculations

As expected, DUK performed quite well. Not only did it improve the yield of the portfolio, it also allowed for volatility reduction. SO, PGN, and PCG also performed well. WEC offered the interesting example of an increased ratio achieved through volatility reduction since its yield is actually below that of XLU. However, the lower new portfolio volatility was enough to offset the lower yield. WEC had a low correlation and a low volatility which provides the greatest benefit in terms of reducing portfolio volatility. As expected, SPY and CEG were the laggards providing less yield for more volatility.

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.

Source: Optimizing Utility Dividend Stock Portfolios: More Yield, Less Volatility