Utility Investments
“There is no way these stocks are boring” exclaims Joey, a grizzled, veteran investor I recently met. “As a matter of fact I’ve done great with these stocks. Besides, Warren Buffet owns them.”
His enthusiasm is not to be outdone. He drew my attention to an industry that many consider boring and sleepy. Ten years ago, these companies were relegated to widows, orphans, and retirees. These investments are widely considered the safest and most secure in the stock market. If you didn’t want much risk, this was the industry for you.
What industry am I talking about? Utilities of course.
Many investment advisors incorporated utility stocks into portfolios because of their safety. They were seen as something to run to when fears of recession hit, or as an aggressive substitute to bond investing. The perceived safety of these companies is due in large part to government regulation.
You see, most utilities are a monopoly. The government allows them to operate, but regulates them heavily. As a result, the business earnings are limited to a fixed return on invested capital. This gives the companies great stability and predictability (and makes them rather boring to many).
Utility companies traditionally produce, generate, or distribute electricity or natural gas. Recently, the industry has grown to include water companies as well. These businesses are very basic. People will always need electricity, gas and water.
You may know that a few years ago the industry started to change. The government started to deregulate parts of the business. This opened the floodgates to improved production, and allowed for the emergence of independent power producers. Suddenly, some utility companies could make more than a standard fixed rate of return. The industry became a very exciting one to invest in, and Wall Street took notice.
However, once the initial excitement started to wear off some cracks started to appear. You all remember Enron. Clearly deregulation caused a number of unintended consequences that took a few years to work out. The first few years were a bit rough as the negative publicity caused investors to flee.
Despite the turmoil, demand for electricity continued to grow. Customers had a growing need and a few years later stability returned to the industry (and the stock prices of these companies). As a matter of fact, the returns over the last few years have been phenomenal.
The top holdings include Exelon (EXC), FPL Group (FPL), Dominion (D), and Public Service Enterprise Group (PEG). Clearly, ownership is growing beyond widows, orphans, and retirees. This ETF is up more than 69% in the last three years alone!
Superstar investor Warren Buffett also owns the utilities. Most recently, he bought a stake in TXU junk bonds. This adds to his position as majority owner of MidAmerican Energy Holdings. MidAmerican is a large utility with operations in the United States and Britain.
To us, the utility industry is no longer boring. With the phenomenal returns they have posted in the last few years, investors have started to take notice again. The presence of great investors like Warren Buffett indicate that big returns can still be made.
One great way to profit from this industry is through the Utility Select Sector SPDR (XLU) mentioned above. It provides exposure to a number of leading companies and has an attractive yield of over 2.5%. If current trends hold, this could be a very easy (and very boring) way to make 20% over the next 6-18 months.
Category: Commodities
