The Dichotomy Of Utility Dividends

A lot of income investors think of utilities stocks as dividend nirvana. Good payouts and high yields from companies that provide an essential service and face little in the way of competition. If only things were that easy. There's no such thing as a free lunch, especially in the world of investing, and income investing in the utilities sector proves that.

Utilities are known for paying out a big chunk of their net income in the form of dividends, which is nice and that results in high yields, but that can also result in anemic dividend growth and the potential for dividend cuts. Many utility companies will raise their dividends for an extended period of time, particularly when interest rates are low, only to slash the payout back to or close the starting point. Then the increases will resume and the pattern begins again.

That makes buy-and-hold dividend investing with utilities somewhat risky. For investors that need immediate income, the utilities sector will work, but for investors that are building a long-term income generating portfolio, it pays to be extremely selective when it comes to the utilities space. Take a look at the chart below to get a sense for what a mixed bag utilities can be when it comes to dividends.

One sub-sector of the utilities universe that has delivered tidy returns over the past year and still has some gas left in its tank (no pun intended) is the gas utilities group. Despite the fact that natural gas prices have been depressed for several years now, consumption of the commodity is rising in the U.S. and if any congress and president (not just the current ones) want to make a real go of reducing America's addiction to foreign oil, natural gas is going to have to be part of the equation.

Projections show that industrial natural gas demand will increase from 7.3 trillion cubic feet in 2009 to 9.4 trillion cubic feet in 2020, according to Insider Monkey. Insider Monkey actually published a list of 15 gas utilities with yields of at least 3.5%, so as you can see, this corner of the utilities market is chock full of prospects for savvy income investors.

Several of the names on the list are stocks we have recommend to clients and subscribers over the past few years and names we continue to like today. One example would be propane utility AmeriGas Partners (NYSE: APU). The dividend has grown by almost 60% since 1995 and the shares currently yield 6.1%.

That's just one example in an area where there plenty more just like that, but AmeriGas and some of its peers do illustrate the point that looking for a lengthy history of dividend growth is a rewarding strategy in any industry and utilities are no exception.

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