Investing in Electric Utility Stocks

Electric utility stocks are publicly traded companies regulated by government agencies that make money by providing reliable power to customers. Here’s a closer look at how to invest in the electric utility industry.

The best electric utility stocks listed

Several publicly traded companies operate electric utilities, giving investors lots of options in this sector. Three that stand out as being among the best in the electric utility sector are:

1. Duke Energy (NYSE:DUK): A regulated electric and natural gas utility that serves electric customers in six states.
2. NextEra Energy (NYSE:NEE): An energy holding company that operates two electric utilities in Florida and a leading renewable energy business.
3. Xcel Energy (NASDAQ:XEL): A regulated electric and natural gas utility that serves eight midwestern states.

Here’s a look at what makes this trio stand out as solid investments in the electric utility sector.

Duke Energy

Duke Energy (NYSE:DUK) is one of the largest energy holding companies in the country. It operates three business segments:

• Electric utilities and infrastructure: Operates regulated utilities that serve 7.8 million retail electric customers in North Carolina, South Carolina, Florida, Indiana, Ohio, and Kentucky.
• Gas utilities and infrastructure: Distributes natural gas to 1.6 million customers across North Carolina, South Carolina, Tennessee, Ohio, and Kentucky.
• Duke Energy Renewables: Operates wind and solar generation facilities across the U.S., as well as energy storage and microgrid projects.

Duke Energy’s portfolio of utilities generates steady rate-regulated revenue. Meanwhile, its nonregulated renewable energy business produces stable cash because it sells the power produced under long-term, fixed-rate power purchase agreements (PPAs) to other utilities and end users.

Duke Energy stands above many other utilities because it complements its steady revenue-generating ability with a strong financial profile (including an investment-grade credit rating) and a conservative dividend payout ratio, giving it the flexibility to invest in cleaner energy.

Those expansion-related investments position Duke Energy to grow its earnings per share at a 4% to 6% annual rate through 2024. Add that steady growth to Duke’s dividend, and investors could enjoy attractive total returns.

NextEra Energy

NextEra Energy (NYSE:NEE) is one of the largest electric utilities in the country, owning two separate companies in Florida that serve roughly 5.5 million people. It also operates a competitive energy business that generates and sells electricity under long-term PPAs. This business is the world's largest generator of renewable energy from the wind and sun.

NextEra Energy has all the qualities an investor would want in a utility. It routinely has one of the highest credit ratings among large, rate-regulated electric utilities. It also typically has a lower-than-average dividend payout ratio. That gives NextEra the financial flexibility to invest in making its utilities cleaner while building more renewable power projects.

Those investments should expand NextEra’s earnings by 6% to 8% annually through 2023 while growing its dividend by 10% per year through at least 2022. That’s above-average growth for the sector, which could help NextEra generate industry-leading total stock returns.

Xcel Energy

Xcel Energy (NASDAQ:XEL) operates four electric and natural gas utilities across eight states in the central U.S., serving 3.7 million electric customers and 2.1 million natural gas customers. Those businesses generate predictable rate-regulated revenue.

Xcel Energy’s excellent qualities include an investment-grade balance sheet and a conservative dividend payout ratio. Its strong financial profile gives it the flexibility to invest in high-return expansion opportunities, such as replacing coal-fired power plants with wind power. The company believes these investments can transform it into a cleaner electric utility that can grow its earnings and dividends per share at 5% to 7% annually. That steady growth should give Xcel Energy the power to produce attractive total shareholder returns.

How to find the best electric utility stocks

Investors need to understand how to analyze electric utility businesses in order to find companies with the potential to generate attractive total returns. Three main factors have contributed to outperformance in the sector over the years:

1. Financial strength

Having a strong financial profile is vital for an electric utility, because it needs to fund the maintenance and expansion of its infrastructure while also paying an attractive dividend to its shareholders. One of the key ways to gauge the financial strength of a utility is to see whether it has an investment-grade credit rating on its bonds. That’s similar to a high credit score, suggesting the borrower is at low risk of defaulting on its debt by failing to make payments. An investment-grade rating means a company can borrow money at lower interest rates and better terms.

2. A conservative dividend payout ratio

Utilities pay out a significant percentage of their earnings to investors via their dividend (usually more than 65%). However, because financial strength is so important, investors should focus on electric utilities with lower-than-average dividend payout ratios. That allows them to retain more cash to finance growth, which enhances their financial strength.

3. Consistent earnings growth

The best utilities can steadily grow their earnings per share by investing in initiatives that earn high returns on investment. For example, utilities can increase their profitability by retiring aging and expensive coal-fired power generation plants and replacing them with cheaper, cleaner ones powered by natural gas. Likewise, they can expand their earnings by taking advantage of tax credits and other incentives to build out renewable energy projects.

Investors seeking electric utility stocks to buy should look for these three characteristics. These strengths should provide the company with the financial flexibility to steadily grow its earnings and its dividend. And those two factors help power an attractive total stock return to shareholders -- the combination of a stock’s dividend yield and its stock price appreciation.

Why are electric company stocks good investments?

It costs lots of money to build and maintain electricity-generating plants and electrical distribution systems. Because of that, governments give electric utilities a monopoly to operate in a specific region, meaning they're the only company allowed to operate a power distribution system. Government entities then regulate these companies by approving the rates and fees they can charge customers for providing them with electricity. As a result, electric utilities generate predictable revenue -- a desirable feature for those seeking lower-risk investments.

Electric utility stocks also typically pay a dividend, which is a cash payment of a portion of the company's profit, to their investors. Utilities generally offer an above-average dividend yield -- the ratio of a company's annual dividend to its stock price. That's because they choose to pay out a larger share of their profit instead of retaining it to expand their operations. The sector's higher dividend yields make these stocks attractive income investments for retirees.