Utilities are the classic “widow-and-orphan” stocks. This phrase is most closely associated with stocks that provide reliable returns over time, ideal for investors who shy away from volatility. For investors who value stocks that pay high dividends, such as those investors in or nearing retirement, utilities have been relied upon as steady providers of dependable income for many decades.
While earnings per share growth isn’t going to take anyone’s breath away, utilities operate in a highly regulated industry and thus aren’t likely to collapse. Utilities are therefore critical to the prosperity and security of the nation. Even in a dire economy, utilities provide investors the certainty of reliable earnings and dividends.
There are many publicly traded utility stocks for investors to choose from. Two of the most well-known are The Southern Company (NYSE:SO) and Duke Energy Corp (NYSE:DUK), which both provide dependable results and carry hefty dividend yields. Are these two worth buying? Or is there a better utility to buy today?
The downside of slow-and-steady stocks
As previously mentioned, utilities are valued highly by many investors for their strong dividend yields and reliable results. These stocks are also not very volatile, which helps investors sleep at night, knowing they likely won’t wake up the next day to find their utility stock had gone out of business.
There’s of course a cost for this dependability, which in the case of utility stocks, is low growth. The Southern Company (NYSE:SO) and Duke Energy Corp (NYSE:DUK) both yield in excess of 4% at recent prices, but they have been slow to grow their dividends over the past several years.
In fact, five-year compound annual growth in dividends for The Southern Company (NYSE:SO) and Duke Energy Corp (NYSE:DUK) is just 4% and 3%, respectively.
Moreover, earnings growth for Southern and Duke Energy Corp (NYSE:DUK) going forward isn’t likely to justify the fairly exorbitant valuations both stocks enjoy. The Southern Company (NYSE:SO) reported fiscal 2012 earnings per share grew 5%, while Duke Energy’s adjusted diluted EPS actually fell 1% last year.
However, none of this should be taken as a surprise. Utilities are never going to be high-growth stocks. What disturbs me most about The Southern Company (NYSE:SO) and Duke Energy Corp (NYSE:DUK) are their valuations.
Each stock has rallied considerably over the past couple years. As a result, investors are now paying hefty prices for these stocks in search of yield. To illustrate, consider that each of these two stocks currently trades for more than 18 times trailing EPS. Plainly stated, there isn’t much underlying value left in these two stocks.
There are still reasonably priced utility stocks out there
Fortunately for investors, not all utilities trade in excess of 18 times trailing earnings while simultaneously offering little underlying growth.