The Power of Dividends in 2 Charts: Water Utilities

Investing in dividend-paying stocks might not be as endorphin-pumping as hunting for the Next Big Thing while it's still flying under the radar. However, if your goal is to pump up your bank account, you might consider investing in dividend payers. 

Chart 1: Average annual return by dividend policy 

Invesco from Ned Davis Research

Here's what $10,000 invested in each category would be worth at the end of the 30-year period:

  • Dividend Growers & Initiators: $152,200
  • All Dividend Payers: $125,560
  • Dividend-Payers with no Change: $80,500
  • Non-Dividend Payers: $16,100
  • Dividend Cutters & Eliminators: $9,140 

The backdrop is set, so let's hone in on water utilities. 

Chart 2: The Power of Compounding & Reinvested Dividends

American States Water (NYSE: AWR  )  primarily operates as a water utility in California. I'm using it to show the long-term power of compounding because I've previously called it a top water stock and, unlike most of the other water utilities, it's traded for at least 25 years. 

AWR Total Return Price Chart

YCharts

Here's what $10,000 invested 25 years ago would be worth: 

  • American States: $173,000 (68% from the reinvested dividends)
  • S&P 500: $109,000 (42% from reinvested dividends)

Not only did American States' total return significantly outperform the market, it did so with less risk. It has a beta of 0.54 vs. the market's 1.0. 

Water utilities: DRIPing with attractive features 
Water utilities are attractive because: (1) they're monopolies or near-monopolies; (2) water supply is limited and will likely shrink due to long-term warming; (3) demand should increase; and (4) water has no substitutes. 

Interest rates have risen over the last few months, and utility stocks usually perform best when rates are decreasing. However, rates are still near historical lows. Ideally, you should take advantage of dividend reinvestment plans, or DRIPS, and invest regularly, so you'll be investing as rates move both up and down.

Water utilities with market caps of at least $300 million

Company

Div. Yield

Fwd. P/E

5-Yr PEG    

3-Yr Avg Rev Growth

3-Yr Avg EPS Growth

Profit Margin

ROE

American States Water

3.1%

18.6

9.1

9%

20.3%

12.4%

13.2%

American Water Works 

2.9%

16.5

2.4

5.6%

0%

12.8%

8.3%

Aqua America  (NYSE: WTR  )

2.5%

20.0

 3.7

4.2%

22%

28%

15.4%

California Water Srv.  (NYSE: CWT  )

3.3%

18.0

 3.8

7.6%

6.3%

8.4%

9.2%

Connecticut Water Srv.

3.3%

18.2

 3.9

12.2%

8.7%

16.8%

9.3%

Middlesex Water

3.8%

19.4

 7.6

6.6%

7.7%

14.3%

9%

SJW Corp

2.8%

18.8

 1.4

6.6%

13.4%

9.2%

8.6%

Yahoo! Finance & Morningstar; data to Sept 13.

American States, which has a $1 billion market cap, provides water to communities in northern, southern, and coastal California; and electric service to the Big Bear Lake region. Its services subsidiary operates and maintains water and wastewater systems on military bases throughout the U.S. 

Its 2012 results were strong, as revenue and EPS from continuing operations increased 11.2% and 26.5%, respectively. More recently, second-quarter results were solid, with revenue rising 5.3% and EPS increasing 7.6%. Its core water utility segment's contribution to EPS rose 18%. It hiked its dividend 14.1%, effective Sept. 1. The company has paid dividends every year since 1931 and has increased its dividend each year since 1954.

Aqua America, currently yielding 2.5%, is a water utility to consider. It's a $4.2 billion market cap providing water and wastewater services to customers in PA, VA, NC, OH, IL, NJ, IN, and TX. It divested most of its Florida businesses earlier this year, and is selling the remaining ones.  It also supplies water to energy producers for hydraulic fracturing in the Marcellus Shale, a profitable niche.

These two utilities have the best three-year average EPS growth rates and ROEs, and Aqua's profit margin is tops in the industry.

I called these the best two water utility stocks in a July 2012 article, but while I still think they're standouts, American States' sky-high valuation on a 5-year PEG basis precludes me from making such a call again. It regularly beats earnings estimates, so there's reason to believe estimates are too low. However, for many investors, Aqua America is likely the better way to go. 

I've long favored American States, in part, because its territory includes areas where agricultural and other demand should continue to increase due to more frequent and severe drought conditions. Using the same reasoning, investors might consider California Water Service. It supplies water to California, New Mexico, Hawaii, and Washington.  Additionally, it's increased its dividend for 47 consecutive years. SJW also services the California market, however it owns and leases commercial buildings too, so it's not for investors who want a pure-play.

Industry biggie American Water Works? It's had a great run, but it's had growth issues for a few years now. The most conservative investors might consider it; however, select smaller utilities likely have better growth potential. 

Foolish bottom line
Dividend-paying stock have significantly outperformed the market over the long-term and make attractive core holdings for many investors. More specifically, the water utility industry is gushing with attractive features, with Aqua America spouting top metrics. 

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