I’ve made no secret of the fact that if there is a dividend bubble in the market, it seems likely that this bubble rests squarely above the utilities industry. While it’s true that utilities offer yields that are far superior to many other seemingly “safe” investments like CDs and bonds, they are not without risk. It seems that these stocks are being bid up to their current prices based on yield alone. However, if you want exposure to a utility stock in your portfolio, one of the best options might be The Southern Company (NYSE:SO).
This Sounds Familiar
Utilities have long been bought to add safety and yield to a portfolio. However, in the current environment, I can’t help but hear Peter Lynch in the back of my mind. He mentioned that before the 1987 stock market crash, some slow growing companies were trading for 10 or 15 times earnings, yet they were only expected to grow EPS by single digits. He went on to say, that in his view a company’s stock should trade at a P/E ratio equal to their expected growth rate. He also said when slow growing companies are trading for growth stock multiples, investors need to be cautious. Tell me if any of this sounds familiar?
Today’s market holds several utilities in high regard, and their shares trade for P/E ratios reserved for faster growth companies. For instance, Southern Co. trades for a forward P/E ratio of 15.81, Duke Energy Corp (NYSE:DUK) trades for 15.8, Consolidated Edison, Inc. (NYSE:ED) sells for 14.8 times earnings, and Exelon Corporation (NYSE:EXC) still trades for over 12 times earnings. With analysts calling for negative growth at Exelon, to mid-single digit growth (4.86%) at Southern Co., these companies aren’t expected to set the world on fire. The bottom line is, these stocks are not traditionally cheap, and investors need to know what they are paying for.
The Yield Is Top Notch
For all of this caution, there is some good news at least for Southern Co. investors. First, the company pays the highest “safe” yield of the group. I know that Exelon investors are crying foul right now, but notice I added the word “safe” to my description of Southern Co.’s yield. Like it or not, there is a dark cloud hanging over Exelon today.
Exelon’s CEO Christopher Crane said that the company might, “revisit our dividend policy.” He specifically mentioned that pricing would need to play out the way the company expected. If pricing did not come in according to expectations, the dividend could be at risk.
With Exelon effectively removed from the conversation, this leaves Southern Co.’s yield of 4.49% at the top of the heap. Duke is very close behind at 4.44%, and Consolidated Edison pays 4.27%. These yields might sound interchangeable, until you realize that these companies have very different growth rates.
Better Growth And Margins Too
While an expected growth rate of 4.86% doesn’t sound like much, in light of 2.4% or 2.95% growth, I’ll take it. Unfortunately, Exelon shareholders are knocked out of this comparison, as analysts expect the company’s earnings to shrink in the next few years. Southern Co. is expected to grow earnings by 4.86%, Duke is expected to post growth of 2.95%, and Consolidated Edison is expected to grow by 2.4%.