Source: Pictures of Money via Flickr.
Dividends are the foundation to which great retirement portfolios are built. Unfortunately, not all dividend stocks are created equally. Some have the potential to lift your portfolio to the next level, while others could be unsustainable over the long run. This is why it's so important to dig below the yield itself into the underlying business model of a company to get the full story.
With that in mind, we asked four of our dividend sleuth contributors to dive headfirst into the utility sector -- comprised of electric, gas, and water -- and select one utility stock that they believe all retirees should own.
Keeping in mind that utility stock dividends regularly outpace the average yield of the broader-based S&P 500, here's what our four analysts had to say.
Dan Caplinger: Utility stocks are useful for retirees because of the income they generate, and American Electric Power (NYSE: AEP) definitely qualifies on that front with a 4% dividend yield. In addition, there are some reasons to believe that American Electric Power could also deliver some growth potential for those willing to add the stock to their investment portfolios.
Source: American Electric Power via Facebook.
Strategically, American Electric Power has embraced its regulated-utility business, with the steady profits that the regulated side of the company earns having substantial appeal to investors. Yet in addition to providing electricity to more than 5 million customers in nearly a dozen states, American Electric Power also has a huge power-generation business, selling electricity to other utilities on the open market. In order to narrow its focus, it's likely that American Electric Power will either sell or spin off its generation business, freeing up capital to dedicate toward growing its regulated distribution network and potentially picking up more assets on that side of the company. With the company expecting to spend almost $5 billion in the next three years on transmission-related projects, American Electric Power is in a good position to cash in on industry growth and give retirees some capital appreciation to go with their steady dividend income.
Sean Williams: Although it may not be the most original selection, I believe all retirees should own shares of NextEra Energy (NYSE: NEE) in their retirement or investment accounts.
First of all let's get through the basics: utilities offer a basic-needs good (electricity), and as such they deliver pretty predictable cash flow and dividends. With the exception of the increasingly rare unregulated electric industry, investors often have a good idea of what sort of growth to expect from utilities, which sans acquisitions tends to be about 2%-5% growth per year. NextEra Energy is currently pumping out a 3.1% yield to its shareholders, or about a 50% premium to the average yield of the S&P 500, and its five-year growth rate looks to be about 6% based on Wall Street's estimates.
Source: U.S. Energy Information Administration via Facebook.
What separates NextEra from the pack has been its focus on renewable energies. Even though it freely uses debt financing to fund its renewable push (implying its debt levels could weigh down its share price a bit), renewable energies such as wind and solar power are going to give NextEra a competitive cost advantage over its peers for potentially decades to come.
NextEra currently boasts nearly 11,300 net megawatts of generating capacity just from wind! For context, that's about 20% of its total generating capacity. In 2014, NextEra was able to generate 700 MW from solar power and has plans to bring significantly more online in the coming years. It even has 6,600 MW of capacity from nuclear plants, which are also a clean source of energy relative to coal. As the leading provider of wind- and sun-based generating capacity, NextEra is also a blip on the radar when it comes to CO2 emission. This means seniors have little worry about government regulations putting NextEra in a bind.
If retirees need a stable income-producing stock to buy and hold for a long time, I'd suggest they give NextEra Energy a closer look.
Rich Smith: When it comes to picking a dividend stock, size isn't everything. In fact, sometimes, you may have better luck finding better investments when looking where other investors aren't. A great place to start such a search is among small-cap utilities ... utilities other than power companies ... and maybe, just maybe:
Middlesex Water (NASDAQ: MSEX).
Valued at just $370 million in market cap, and operating in the oft-overlooked sector of water supply and wastewater treatment, Middlesex isn't the first name that pops to mind when looking for a utilities investment -- but it has a lot of the attributes I like to see in any potential investment.
Source: Middlesex Water via Facebook.
Middlesex Water is profitable, for one thing, earning nearly $19 million last year -- enough to give the stock a reasonable P/E ratio of less than 20. It's growing modestly, with a long-term annual earnings growth rate estimated at just under 3% by analysts polled on S&P Capital IQ.
The company's debt load, while not insubstantial at $159 million, is at least manageable. And unlike so many other utilities, Middlesex is generating decent free cash flow from which to fund its operations going forward (and pay down that debt). Over the past 12 months, S&P Capital IQ data show Middlesex generating more than $12 million in positive cash profits.
To top it all off, Middlesex pays shareholders a strong 3.4% dividend yield, and with a dividend payout ratio of only 67%, should be able to maintain (or increase) those payouts for a long time to come.
Bob Ciura: I'm a big fan of Consolidated Edison (ED 1.47%) as a great utility stock for retirees. Presumably, retirees construct their portfolios around income, and ConEd is about as solid of a dividend stock as you can find. As a regulated utility, ConEd enjoys a very steady stream of profit, and is able to pass along satisfactory rate increases each year to keep modest growth intact.
Source: Con Edison via Facebook.
ConEd is displaying the slow-and-steady growth that is more typically associated with utilities. Its earnings per share grew 2% last quarter, thanks to higher rates, as well as lower operating and maintenance expenses. Looking back further, ConEd grew EPS by 3% last year.
These aren't huge growth rates of course, but utilities aren't relied upon for growth. ConEd's growth is more than enough to continue paying its dividend, as well as providing modest dividend increases each year. Plus, management expects 2015 to be another successful year. The company raised full-year guidance after its first-quarter earnings report. ConEd expects to earn $3.97 per share at the midpoint of its forecast, which would represent 6.5% growth from 2014. This is a very healthy growth rate for a utility.
At its recent $61 closing price, ConEd offers a hefty 4.25% dividend yield. Even better, ConEd is an ideal dividend growth stock. The company has increased its dividend for an impressive 41 years in a row. For these reasons, I'd suggest retirees consider adding ConEd to their portfolios.
