The uncertainty and market volatility of 2020 refuses to die down. With the fears of another round of pandemic lurking, the S&P 500 could face a massive downturn in the near future.
Economic numbers aren’t looking great either. The unemployment figures are at multi-year highs which means consumer loan defaults may rise in the near future. Further, the vaccine for coronavirus is nowhere in sight.
However, instead of hitting the panic button, it is wise to use this opportunity to build one’s portfolio with quality stocks. As several stocks are trading at a discount, the trick is to look at the long-term growth potential of the companies and not just their current performance.
Utility sector is an option for conservative investors
So instead of picking individual stocks, the investors must focus on sectors which has strong fundamentals and the ability to sail through rough seas. Besides the quintessential healthcare sector, utility is one sector that is crucial for the efficient functioning of the economy.
Consumers and industries will always pay for essential utility services across economic cycles. Generation and distribution of electricity, water and gas are the services which comprise the utility sector. Even the red-hot technology and computing sector wouldn’t be fully functional without the utility sector. However, due to the lockdown situation, the industrial demand for utilities have softened in the recent past.
One of the highlights of the utility sector is that the public state commissions govern them. This implies that the pricing of the services is regulated and not exposed to volatility. As a result, utility companies have stable and transparent cash flows.
Talking of the current situation, investors haven’t been too excited about the utility stocks. S&P Global reports that in the second quarter of 2020, many institutional investors reduced their holdings in the leading oil and gas producers by 50%.
For the month of August, S&P 500 Utilities index dropped by 2.6%. Evergy Inc.(NYSE: EVRG) and American Electric Power (NYSE: AEP) are amongst the top losers among the utilities sector.
Utility stocks have the ability to pay and maintain dividends across cycles
One of the biggest factors that make utility companies attractive is their ability to pay and sustain dividends across business cycles. The Co-Chief Investment Officer at ClearBridge Investments, Scott Glasser, indicated that the average dividend yield of the utility sector stocks range between 3.5% and 5.99% which is twice the interest rates of treasury bond yields.
Most of the leading utility companies have a record of maintaining the payouts and even raising them over time. Hence, utility stocks are one of the most suitable option for income investors.
According to a data by Factset, only eight out of 28 utility companies in the S&P 500, have lowered their dividend payouts over the past fifteen years. The most recent dividend cuts were done by CenterPoint Energy (NYSE: CNP) and Dominion Energy (NYSE: D) in April and July, respectively.
Resistance to economic cycle lures investors
Utility is a capital-intensive industry with a slow pace of growth. However, there is still lot of scope to make money from investing in these stocks. These businesses tend to see a rise in their earnings when they invest in the expansion or improvement of their infrastructure that includes electric grids, and pipelines among a few.
Investors need to be very prudent in choosing the right utility stock. The ones involved in regulated electricity and power distribution are better bets that the ones operating in the wholesale space.
Utility companies also face a unique set of challenges. The climate-change related catastrophes are likely to accentuate in future and are unpredictable. The cost of maintaining the infrastructure and replacing it under dire circumstances is also high. They add to the operating costs and liabilities for the players owing to high maintenance.
However, for conservative investors, utility companies are lucrative options, as their demand elasticity is low. They are resistant to economic cycles and have stable revenue streams.
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