How to Reap Big Dividends From the Utilities Sector


Source: DTEEnergy.com.

Exchange-traded funds offer a convenient way to invest in sectors or niches that interest you. If you'd like to add some utility companies to your portfolio but don't have the time or expertise to hand-pick a few, the Utilities Select Sector SPDR ETF (NYSEMKT: XLU  ) could save you a lot of trouble. Instead of trying to figure out which stocks will perform best, you can use this exchange-traded fund to invest in lots of utility companies simultaneously.

Why this ETF, and why utilities?
While some industries, such as automakers and large-appliance makers, see their fortunes rise and fall along with overall economic conditions, other industries, such as utilities, are more "defensive." Their offerings remain in demand no matter what the economy is doing. (Think about it: You're not going to use much less electricity if the economy is slumping.) Better still, many utility stocks pay substantial dividends. The industry isn't quite as predictable as it was before it was deregulated, and it's being disrupted a bit by alternative energies, but energy use will only keep increasing over time.

ETFs often sport lower expense ratios than their mutual fund cousins. This ETF is no exception, with an ultra-low annual fee of 0.16% -- far lower than most other ETFs. It has outperformed the world market over the past 10 and 15 years, though it has lagged over the past five. The ETF recently yielded about 3.3%.

A closer look at some components
On your own you might not have selected DTE Energy Co (NYSE: DTE  ) or Consolidated Edison  (NYSE: ED  ) as utility companies for your portfolio, but this ETF included them among its 30-some holdings.

DTE Energy
DTE Energy is a Michigan-based utility company with a market cap near $13 billion and a 3.6% dividend yield (which was recently hiked by 5.3%). Detroit's meltdown hasn't helped business, but as the city tries to get back on its feet, DTE stands to benefit. In a presentation in April, management pointed to falling unemployment and rising housing starts in Michigan over the past few years.

The company's last reported quarter featured operating revenue jumping 56% and earnings per share surging 37%, thanks in part to a severe winter that boosted demand for power. Management noted that it actually reduced its electricity rates by 6.5% in January, and also pointed to solid growth from its non-utility businesses, such as gas storage, pipelines, and energy trading. It's targeting 5% to 6% annual growth in coming years.

Not everything about DTE is perfect, though. Its top line is growing well, but profit margins and free cash flow are shrinking a bit. Part of the reason is growth in capital spending as DTE Energy invests in future growth. For example, it recently bought a 75-megawatt wind farm as it grows its alternative-energy operations. The company expects to be generating about 10% of its power sales from renewable-energy sources by next year.

DTE has been rewarding its long-term shareholders well, averaging 13% annual stock-price growth over the past 30 years and 24% over the past five. Unfortunately, its stock price looks like it has gotten ahead of itself, with its forward P/E of 16 well ahead of its five-year average of 14. Interested investors might want to add it to a watch list and wait for a pullback.

Consolidated Edison
Consolidated Edison, or ConEd, serves customers in New York, New Jersey, and Pennsylvania, and offers investors a 4.4% dividend yield. It has been benefiting from many in New York and elsewhere switching from oil heat to natural gas -- indeed, New York City is phasing out certain kinds of heating in order to improve the environment.

It has challenges, though, such as needing to deploy more than $8 billion in capital spending as it upgrades its infrastructure. It can pass on some of that cost to customers via rate increases, but only when they're approved by regulators. The company's last quarter featured revenue and earnings topping expectations. Its earnings have been growing faster than revenue, too, reflecting cost-cutting and improved efficiency.

With a forward P/E ratio not far from its five-year average of 15, slow dividend growth, and slow revenue and earnings growth, ConEd isn't the most compelling investment for many portfolios. If your primary goal is income, though, you might consider it, for its historically reliable dividend alone.

The big picture
It makes sense to consider adding some utility companies to your portfolio. You can do so easily via an ETF. Alternatively, you might simply investigate its holdings and then cherry-pick from among them after doing some research on your own.

More solid dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend-paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.


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