How to Invest in Utility Stocks

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Utility stocks are considered some of the most conservative equity investments because they represent companies in stable, mature and partially regulated industries. On one hand, utilities have limited room for growth; on the other hand, they have predictable cash flows and pay rich quarterly dividends. Utility stocks are most suitable for conservative investors and retirees seeking predictable equity income and some growth.

  • Get a list of all utility stocks by using a free online stock screener to make meaningful comparisons. Limit your selection to stocks priced $15 and above that are trading at least 100,000 shares daily.

  • Rank the stocks on the list by current dividend yield--the starting point of your research selection.

  • Get the dividend growth rate for the past five years. When a company increases its dividend, the rule of thumb is that its stock will appreciate in approximately the same proportion because investors are willing to pay more for a higher dividend. For example, a 10 percent dividend increase may result in a 10 percent price appreciation. Add the dividend growth rate to the current dividend yield and re-rank your stocks.

  • Check the dividend payout ratio, which is the percentage of net income paid out in dividends. Eliminate the stocks with a payout over 100 percent as it is unsustainable and may result in a dividend cut in the near future. An even more conservative approach would be to limit your selection to stocks with a payout of 80 percent or less.

  • Select the top five or 10 candidates with the highest combined dividend yield and dividend growth numbers. These are your best candidates.

  • Use DRIP (dividend re-investment plan) to buy additional shares with the dividends if you don't need the income.

  • Re-balance your portfolio annually by repeating this process. Sell the stocks that are no longer at the top of the list and replace them with the new top candidates. You will be rotating your money out of stocks that have appreciated in value into cheaper ones with the most appreciation potential.

Tips & Warnings

  • If you don't want to do your own research, buy a utility mutual fund.
  • Don't be turned off by a recent dividend cut. Dividend cuts are usually a last resort, so when it happens, things are typically as bad as they can get and can only improve from there, so the dividend is more likely to be increased going forward.

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References

  • "One Up on Wall Street"; Peter Lynch; 1989
  • Photo Credit Power plant image by MAXFX from Fotolia.com
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