Utilities are normally seen as old-fashioned, uneventful companies to buy equity in, and they usually are. But depending on your investment goals, their not-too-shabby dividends might have some appeal.
Take electric utilities for instance. Their average dividend is around 4% and their earnings are extremely reliable. Like any stock investment, it's certainly not a sure thing, but it's also not something you're likely to lose sleep over. American Electric (NYSE:AEP), FirstEnergy (NYSE:FE), and PSEG (NYSE:PEG) all pay out dividends above 3%.
Sounds great, right? But before digging into the financials of your favorite electric company, you should beef up on your industry knowledge. For example, electric utilities are allowed to have a monopoly on power distribution in their region, but they must serve all customers and charge fair rates. This means that if the utility wants to raise rates, it has to submit a proposal to the state. And sometimes, as Central Vermont Public (NYSE:CV) recently learned, these rate plans are rejected.
So it's not like operating the Washington Post, where owners are able to generate double-digit returns on equity by cranking up ad prices. Regulated monopolies don't have that luxury.
Another industry point worth considering is "deregulation." This doesn't apply to the distribution side discussed above. Companies with an infrastructure of power lines still have a monopoly over the distribution of electricity. The deregulated side, which is adopted on a state-by-state basis, is power generation. Many customers can choose who provides the actual power that gets pumped into their home or business. If the local utility's generators aren't efficient, they can switch providers and save money.
The affect of this ongoing deregulation must be considered before investing in any utility. Some companies will use it as an opportunity to expand into other business models, as PSEG has done, while others, like American Electric, will stick closer to a traditional model. The traditional model provides the most stable dividend, assuming the company generates power at a competitive rate. Our very own Mathew Emmert has recommended one such business to his Income Investor subscribers: Southern Company (NYSE:SO), which boasts a 4% yield. Utilities like these may not have high growth potential, but they can limit your downside and provide a hefty payout.
Fool contributor Matt Thurmond owns no stock in any of the companies mentioned above.
