Flipping The Switch On High-Yield Utilities

By Aaron Levitt | February 17, 2010 AAA

2009 was a year of power outages for utility stocks. The providers of electricity, water and gas failed to perform better than the broad market, with the Utilities Select Sector SPDR (NYSE:XLU) trailing the S&P 500 by nearly 10%. As a whole, it was the weakest of the 21 sectors tracked by Morningstar, producing a total return of only 18%. As the previous year's underdogs, 2010 could be the year for getting into utilities. The sector offers great income and capital gains potential as many investors look to add a level of safety to their portfolios. (Learn more about utilities, see: Trust In Utilities.)
IN PICTURES: P/E of around 15, and the XLU at around 12.

While financial stocks spent most of 2008 and 2009 paying their dividends to Uncle Sam in the way of TARP interest, utilities provided their shareholders with generous payouts. The average dividend yield for the utilities funds tracked by Morningstar is almost 3%, dwarfing the puny 1.2% yield for large-cap blend funds and the 2.3% yield of the S&P 500. Even Mr. Bonds, Bill Gross of PIMCO, is taking notice, pointing out that the yields on sector stocks have become more attractive than their debt.

Finding Those Juicy Dividends
Investors wanting to add utilities to a portfolio for dividend income have many choices. The XLU currently yields 4.31%, while its sister fund, the iShares Dow Jones US Utilities (NYSE:IDU) yields 3.89%. However, looking at the two ETFs, individual holdings investors can find higher individual yields on many of the stocks.

Southern Company (NYSE:SO) recently received the presidential seal of approval. On Tuesday, the company received an $8.3 billion loan guarantee to build the first nuclear power plant in the United States in 27 years. Partnering with Toshiba and Shaw Group (Nasdaq:SHAW), the utility hopes to have two reactors built by 2016. Aside from its nuclear ambitions, Southern's core regulated power markets have rewarded investors with a 631% return over 15 years (if you considered reinvesting the dividends received). Shares currently produce a spicy 5.5% dividend yield.

Wisconsin based MGE Energy (Nasdaq:MGEE) currently yields 4.5% and recently won a rate increase of about 3.5%, which adds about $2.50 to each bill. The kicker for the stock is its low debt to equity ratio of 0.7, well below the industry average.

Just as many investors have sought emerging markets for capital gains, utility investors can find some real bargains in terms of dividend yield overseas. Brazilian Utility CPFL Energia S.A. (NYSE:CPL) gives access to a growing middle class and higher incomes, while focusing on the stable end of the spectrum. Shares trade at reasonable P/E of 15 and yield 6.3%.

Bottom Line
Although the market passed the utility sector by in 2009, it created an opportunity for investors in 2010. Utilities' stable revenues and high dividends make a good choice for replacing lost income and stabilizing a portfolio. The previous ETFs and individual stocks show the wide range of yields and investments in the area.

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