As interest rates remain at historically low levels, investors searching for income have taken root in a variety of non-traditional asset classes and sectors. Everything from master limited partnerships to floating rate loan funds such as the Nuveen Senior Income Fund (NYSE:NSL) have soared in popularity. Bonds of all types have seen massive inflows of new investor capital. However, with fears of bond bubble growing and the Fed resuming its easing policies, some time-honored sectors may be the best place to find income and growth.
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Flipping a Switch
The utility sector represents a great way for investors to add income to their portfolios while staying relatively safe. In addition, the sector now has an attribute that is overshadowing its "widow and orphan" past: growth. The increasing need for more electricity in both developed and emerging nations coupled with the task of updating an inefficient power grid has put utilities on growth investors' radars. Many utilities have begun the process of upgrading power plants or adding new renewable energy to their mix. The smart grid build-out has spurred new transmission lines and technologies which has upgraded utilities' stodgy image. All of these measures will help boost future profits and ultimately dividends.
By adding utilities to a portfolio, investors get the steady bond-like dividend payments, but also the ability to score capital gains. With the Federal Reserve QE2 plan causing investors to migrate to riskier assets, humdrum utility stocks have fallen behind. (For related reading, see Who Stands To Benefit From QE2?)
The sector, along with the healthcare space, represents one of the few values left in the market. The broad proxy for the industry, the Utilities Select Sector SPDR (NYSE:XLU), which tracks the 34 utilities in the S&P 500, has only gained about 2.5% this year. The full S&P 500 is up around 9.3%. However, with the economic rebound still weak, the sector could see out-performance if it economic growth fizzles or drifts as many analysts are predicting.
A Powerful Portfolio
The previously mentioned Utilities SPDR has a dividend yield of around 4%. This trumps the small 2.6% payment of a 10-year Treasury. The ETF makes it easy to add the sector to a portfolio, but isn't the only option for investors. A mixture of regulated and merchant power producers may offer a better combination of growth and income as well as international exposure.
Formally known as FPL, NextEra Energy (NYSE:NEE) may be one of the perfect examples of a growth utility. The company is one of the largest residential and industrial power providers in the Southern states, but also is one of the largest generators of wind and solar power. NextEra also has exposure to nuclear energy. The utility yields nearly 4% and gives investors access to mature markets and the growing demand for renewable energy. Similarly, merchant power producer AES (NYSE:AES) has made inroads into renewable energy across the emerging markets.
Trading at a cheaper price-to-earnings ratio than the broad sector, NV Energy (NYSE:NVE) offers a discount to the already discounted sector. Providing power to Nevada and the "tourist areas" of California, the firm is at risk of any prolonged housing problems. However, NV recently raised its quarterly dividend payment and now yields 3.7% and has shown signs of income growth.
Finally, going abroad for utility stocks may be a worthwhile proposition as electricity demand is growing in the developing world. The WisdomTree International Utilities (NYSE:DBU) yields more than domestic counterpart, the XLU. Chinese power company, Huaneng Power International (NYSE:HNP), which yields 5%, allows investors to tap into Asian Dragon's growing power consumption.
The Bottom Line
As income seekers have had to put up with historically low rates, many have turned to non-traditional asset classes for yield. However, boring, traditional utilities may offer a better bargain for investors. With high dividends yields and new sources of profit growth, the sector offers the ability to get income as well as capital appreciation. The previous stocks as well as funds like the PowerShares Dynamic Utilities (NYSE:PUI) make ideal portfolio positions to tap the sector.
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