How to invest in electric utility stocks
It's easy to add an electric utility to your portfolio. Here's a step-by-step guide on how to invest in electric utility stocks:
- Open your brokerage app: Log in to your brokerage account where you handle your investments.
- Search for the stock: Enter the ticker or company name into the search bar to bring up the stock's trading page.
- Decide how many shares to buy: Consider your investment goals and how much of your portfolio you want to allocate to this stock.
- Select order type: Choose between a market order to buy at the current price or a limit order to specify the maximum price you're willing to pay.
- Submit your order: Confirm the details and submit your buy order.
- Review your purchase: Check your portfolio to ensure your order was filled as expected and adjust your investment strategy accordingly.
How to find the best electric utility stocks
It's important to know how to analyze electric utility businesses. That will allow you to find companies with the potential to generate attractive total returns. Three main factors have contributed to strong performance in the sector over the years:
1. Financial strength
Having a strong financial profile is vital for an electric utility. It needs to fund the maintenance and expansion of its infrastructure while also paying an attractive dividend to its shareholders.
One of the key ways to gauge the financial strength of a utility is to see whether it has an investment-grade credit rating on its bonds. That's similar to a high credit score, suggesting the borrower is at low risk of defaulting on its debts. An investment-grade rating means a company can borrow money at lower interest rates and better terms.
2. A conservative dividend payout ratio
Utilities pay out a significant percentage of their earnings to investors via their dividends (usually around 65%). However, because financial strength is so important, investors should focus on electric utilities with lower-than-average dividend payout ratios. The lower ratios allow companies to retain more cash to finance growth, which enhances their financial strength.
3. Consistent earnings growth
The best utilities can steadily increase their earnings per share by investing in initiatives that earn high returns on investment. For example, utilities can improve their profitability by retiring aging and expensive coal-fired power-generation plants and replacing them with cheaper, cleaner ones powered by natural gas or renewables.
Likewise, they can increase their earnings by building out new renewable energy projects to support growing demand. Investors seeking electric utility stocks to buy should look for these three characteristics.
These strengths should provide a company with the financial flexibility to steadily expand its earnings and its dividend. Those factors help power an attractive total stock return to shareholders -- the combination of a stock's dividend yield and its stock price appreciation.
Why are electric company stocks good investments?
Electric utility companies have several features that make them attractive investments, including:
- Predictable revenue: It costs lots of money to build and maintain electricity-generating plants and electrical distribution systems, so governments give electric utilities a monopoly to operate in a specific region. Government entities then regulate these companies by approving the rates and fees they can charge customers for providing electricity. As a result, electric utilities generate predictable revenue -- a desirable feature for those seeking lower-risk investments.
- Steady growth: Electricity demand tends to be stable and rises steadily. Catalysts such as economic growth, increased digitalization, and the growing adoption of electric vehicles should power steady growth in demand in the coming decades. That should enable electric utilities to continue investing capital to expand their operations, supporting steady earnings growth.
- Attractive dividends: Electric utility stocks also typically pay investors a dividend, which is a cash payment of a portion of the company's profit. Utilities generally offer an above-average dividend yield -- the ratio of a company's annual dividend to its stock price -- because they choose to pay out a larger share of their profit instead of retaining it to expand their operations. The sector's higher dividend yields make these stocks attractive income investments for retirees.
Future outlook for the electric sector
Over the last 20 years (2005-25), total electricity demand in the U.S. increased by a modest 10%. Most forecasters expect power demand to accelerate over the next 20 years, growing six times faster, or 58% overall, driven by data centers, increased electrification, and the onshoring of manufacturing. Accelerating power demand growth should provide electric utilities with significantly more expansion opportunities, which should drive faster earnings growth rates and higher total returns for investors.
