Utilities. Latin for “not
sexy”. They don’t grow quickly. They’re for conservative investors in the
Greatest Generation only. Blah, blah,
blah…
There are multiple types of utilities. Water, gas, electric, generation,
transmission, and hybrid or multi-varieties come to mind. As a Dividend Farmer, I
like electric utilities for four important reasons.
Barrier to Entry
Warren Buffett likes firms with wide moats. Companies operating in industry sectors
possessing high barriers to entry have wide moats. Consequently, those firms face
little to no competitive pressure that can drive down prices, revenue, and
profitability.
Electric utilities, particularly those with strong
transmission infrastructures, have wide moats. For a given service area like a
city, state, or region, the cost of infrastructure is high and the physical space
in which to have multiple, competing backbones doesn’t exist. Consequently, an electric utility established
in a particular service area benefits from the prohibitive cost of market entry
to competitors and has virtually no chance of facing downward price or market
share pressure.
Monopoly
Because of the competitive barrier to market entry, electric
utilities are de facto monopolies. The only
thing preventing them from pushing their prices through the roof is regulatory
oversight. This regulatory cap, however,
typically allows utilities a reasonable rate of return, roughly in the low
double-digit range.
While such caps limit upside growth potential, the
monopolistic nature of a utility nearly guarantees a solid, positive rate of return
on an annual basis. If you could invest
in a company sporting a high probability of a 10% return each year or one that
might grow 35% one year, then shrink as much the next, which would you prefer? Dividend Farmers know the
answer to that question!
No Substitute
If you consider your home or work environments and the
powered devices in them, nearly all are electric. What’s more, there is no substitute for
electricity. You can’t power the toaster,
microwave, laptop, refrigerator, lights, or air conditioner with natural gas,
or any other matter, unless you convert it into electricity first. While several alternatives exist for
generating electricity, there is no true substitute for electric power in most
cases.
It’s also true to say there are no substitutes for
delivering that electricity to homes and businesses. For 99.9 percent or more of users, the
electricity they need arrives through the barrier to competitive entry, infrastructure,
discussed above. Although there may come
a day when you can pick up a six-pack of batteries that power the whole house
for a week, that day is nowhere in sight.
Super-efficient and low-cost solar cells that deliver all the power a
home or business needs aren’t on the horizon either.
Long-term Trend
As growth in the Internet of Things (IoT) and conversion to
electric or hybrid vehicles continues apace, the trend in electric consumption
is headed in only one direction – up. It’s
true there will be seasonal swings in electric consumption, but the long-term
trend for power consumption is positive and will remain so until Armageddon. As an investor, putting money into an
industry with an unstoppable upward consumption trend over a nearly infinite
timeline seems like a good play, no?
If you think electric utilities should be a solid block in
your portfolio there are 5 utilities among the Dividend Champions growing their
dividends annually for 26 to 49 years respectively. Twenty-one electric utilities are found among
the Dividend Contenders growing their dividends in a range of 10 to 22 years
and 11 more electric utilities are listed within the Dividend Challengers
growing their dividends in a range of 5 to 9 consecutive years.
Not only do electric utilities rock for the reasons noted,
there are plenty of quality firms from which to choose. These utilities pour forth dividends with
limited risk allowing you to take advantage of Albert Einstein’s sage advice –
he who understands compound
interest earns it.