Utility Stocks Reborn: Yields Are Still Good, But Risks Have Risen
REMEMBER the days of yore when Grandma and Grandpa had their hard-earned savings invested in the town's electric or gas utility - or good ol' AT&T? With their high dividend yields, utility stocks were looked upon as closer to bonds than to equities - financial havens with a steady income stream.
No more. Today's grandmother and grandfather may still have money in a public utility, but it is as likely to be a cellular-phone service as the local electric company. And Grandma is probably more interested in ''total return'' - that is, a combination of both share-price appreciation and dividend yield - than just the dividend check for current income.
Moreover, if Grandma is up on the news, she knows that local electric utilities are frequent targets of public ire. Company directors are probably fending off nagging questions about the safety of their nuclear reactors, or about why monthly consumer bills and rate structures are so high. Directors must also be concerned about how they are going to meet price competition from new low-cost energy producers in the current deregulatory climate.
Buying utility stocks can make sense, but investors should be cautious about what they buy, says Nancy Messer, a utilities analyst for A.G. Edwards & Sons, a St. Louis investment house.
A number of problems continue to weigh down the stocks, she says, including concerns about the pace of deregulation and competition, plus the future direction of interest rates. Thus, no more than 4 or 5 percent of an investor's portfolio should be in individual utility stocks, A.G. Edwards suggests.
The interest-rate risk was evident in 1994, when rising rates in the United States caused utility stocks - especially electric-utilities - to perform badly, says Natalie Andrus, an analyst with Morningstar Inc., a financial-services firm in Chicago.
But as rates began to ease this year, utility issues rallied. Still, they have continued to lag behind broader market indexes. The Dow Jones utilities average, for example, has climbed 18 percent this year. But the Standard & Poor's 500 has shot up 29 percent. ''The utilities sector is essentially flat right now, with nothing very exciting going on,'' says Milton Schlein, an associate research director with Value Line, a New York investment-research service.
Still, investors looking for growth and steady income, and downsized, more-focused management teams, can find some attractive companies, Ms. Andrus says. But for most investors, the most prudent course might be to buy into a utilities-linked mutual fund, she says.
Mutual funds offer diversity
A mutual fund provides instant diversity, since the fund manager can shop around among different utility sectors, including electric, water, gas, and telecommunications companies, Andrus says.
Investors can choose from different types of utility funds. Some focus on one or two sectors. The Franklin Utilities Fund, which has posted a dividend yield of 5.26 percent for the trailing 12-month period ending Oct. 31, has had a heavy commitment to electric utilities, Andrus says. For the year-to-date, the fund is up about 23 percent in total return.
Other funds are more diversified, such as the Vanguard Specialized Utilities Fund. It has a trailing 12-month yield of 4.66 percent through October. And for the first 10 months of this year, it is up 26 percent, she says.
Fidelity also has two very successful diversified funds. Fidelity Utilities Fund is up around 24 percent through October, and has a trailing 12-month yield of 3.72 percent. Comparable figures for the smaller Fidelity Select Utilities Growth Portfolio fund are 26 percent and 2.37 percent.
The Fidelity Utilities Fund has pursued both telephone issues as well as electric companies; the Fidelity Select Utilities Growth Portfolio has had an especially heavy commitment to telephone-service company stocks, which have been steady performers in recent months.
In addition, notes Andrus, some funds are heavily tilted to overseas utilities, particularly in emerging markets. But these funds tend to be risky, given political and economic uncertainties abroad.
If investors do buy utilities funds, they should know their objectives, she says. Do they want high yield and investment income? Then a fund like Franklin's or Vanguard's might make sense. Do they want total return? Then something like the two Fidelity funds might seem appropriate. The investor should know what types of utilities the fund manager is buying. Earnings for some electric and gas companies are being shored up by the weather this year - with strong demand for air conditioning this past summer, and for heat now with early snow in some areas, says Andrew Lohmeier, an analyst for Morningstar.
Finally, investors need to stay alert to the general direction of interest rates, experts say. A sudden rise in rates would be bad news for most utility stocks.