Even though the utility sector is a favorite among dividend investors, the payback periods of these stocks are too long to justify focusing on dividends alone. Unfortunately, the hope that dividend investors should "buy, forget, and cash the check" is fantasy since the shortest payback periods for utility stocks were projected to be longer than a decade.
Utility Stock Payback Period Calculations
The number of years it takes for an investment to pay you back is called the payback period. It is a simple and crude measure of risk. Other investment metrics like required return do not always match up to the calculated payback period. This is because required return takes into account how dividend distributions in earlier years are worth more than the same dollar value paid out in the future. (You would be able to reinvest the earlier distribution and earn a return on it, making earlier distributions worth more.)
Since many dividend investors are attracted to high-paying dividend companies on the premise that they can ignore what the markets do and simply focus on their dividend income, the payback period provides a reality-check for how long payback based on dividend payments could take.
Payback period estimates depend on earnings growth and dividend payout ratios. Payout ratios were assumed constant, and dividend yield was projected by taking the minimum of the following:
- Earnings growth over the past five years
- Analyst estimates for earnings growth for the next five years
- Return on equity times the earnings reinvestment rate
The minimum of these measures was then used to estimate dividend growth for the next three years.
Utilities were screened for dividend payback within two decades, dividend yields in excess of the 10-year Treasury yield and payout ratios below 60%. The values of these inputs are provided below:
EPS Growth Past 5Years
EPS Growth Next 5 Years
American Electric Power
Empire District Electric
Public Service Enterprise Group
Abnormal growth will not last forever, and analyst estimates, as informed as they are, are not predictive indefinitely. To address this limitation, a terminal 3% dividend growth rate was applied for every stock in the list after three years of projected growth rates. (Predicting economic growth many years out is impossible, and 3% seemed like a reasonable value.)
Many utility sector stocks have distribution rates which are high enough that the sum of future dividends would equal your initial investment inside of two decades:
Return on Equity
If you want to ignore what prices your securities fetch in the markets, you will be waiting a long time to get paid back. Since all the dividend utility stocks would require more than a decade for payback, investors should rethink a singular focus on dividends before investing in utilities.
What can dividend investors do with these stocks? Since they cannot "buy, forget, and cash the check" they are stuck considering total return including capital appreciation. Fortunately, many of these stocks offer compelling low price-multiples, which are promising for future stock prices. However, to avoid value traps, investors should weigh how cheaply these dividend-paying stocks are trading against measures of quality. In short, prudent investment for income requires more than reading a stock's yield.
Disclaimer: This article was written to provide investor information and education, and should not be construed as investment advice. I have no idea what your individual risk, time-horizon, and tax circumstances are: please seek the personal advice of a financial planner. This article uses third-party data and may contain approximations and errors. Please check estimates and data for yourself before investing.