Utility Stocks: Phone and Power Companies

Welcome to our lesson on utility companies. In this section, you’ll…

• Learn what investors like about phone companies and power producers
• Discover the benefits of dividends
• Buy two utility stocks for your portfolio

The Two Types of Utility Companies

There are two basic kinds of utility stocks, phone companies and power companies.

The Phone Companies

The first type of utility is the phone companies. In the past, phone companies were regulated, and had a limited market and predetermined pricing. This meant that their profit was fixed in advance.

The Power Companies

The second type of utility is power companies. This includes electrical utilities and gas companies. Like the phone companies, they also generally had set markets, set pricing, and a set return.

Of all the different industries we’ve looked at throughout Module Three, the utility sector is the odd sector out. The big difference is this: the stocks of utility companies don’t (at least traditionally) budge much on the price front.

So without the drawing card of rapidly rising profits in the future, how can these companies entice investors to buy their stocks?

The answer…dividends. Dividends are the distribution of some of the company’s profits to shareholders. Most dividends are paid out on a regular basis, at a set dollar amount per share. For example, a company might decide to pay out $1.25 per share in dividends each year to shareholders. So if you owned a 1000 shares of that company – you just made $1,250.

Picking a Power Company

Let’s first buy a power utility. We’re not looking for a company whose stock price will soar. What we’re after is a power company with a nice, juicy dividend. And that’s exactly what NRG Energy Inc (NRG) offers.

NRG Energy Inc is paying out around $1.50 in dividends each year. Now, we can’t tell right off if that’s good, bad or indifferent.

What matters is how much you have to invest to earn that much income. Say NRG Energy Inc’s stock price was $27. You would have to invest 27 in order to earn $1.02 annually. That’s a return of 3.78 percent. That’s not bad at all, considering it’s a stable company…and you also may make some capital gains if the stock price moves up.

Throughout the 2000s, NRG Energy’s stock price behaved pretty much like utility shares were traditionally supposed to. In other words, it didn’t really do much. However, it did pay out quarterly dividends each year all the way along.

Please Note: This is just an illustration example. We are not suggesting you to buy or invest in NRG Energy.

Most stable companies offer dividends to their stockholders. Since the share price may not move much, dividends make up for this.  High growth companies don’t offer dividends because all their profits are reinvested to help sustain growth.  Long-term investors who want to maximize their gains should consider reinvesting any dividends.

Dialing up a Phone Company Stock

Like power utilities, phone companies also used to be a highly regulated business. They had certain markets set out for themselves, and the rates they could charge to consumers were also negotiated with regulators.

While the industry has rapidly entered the free-market world, many phone company stocks still tend to offer decent dividends.

In this category, we could buy AT&T (listed on the NYSE). Not only is it one of the largest phone companies in the world, it yields a reasonable 2 percent a year dividend. In the UK we have Vodafone (listed on the London Stock Exchange)

Breaking with Tradition: The Upside of Utility Stocks

As we said earlier, phone and power companies traditionally add a terrific underpinning of stability to any portfolio due to their fixed and steady stream of dividends.

But investors are starting to get charged up on utility stocks for another reason. Some utility stock prices are breaking with tradition and offering attractive capital gains.

Deregulation has led to uncertainty and opportunity for the phone companies. As they fight for market share and offer new products, they have the potential to boost their bottom line. If they do, investors should be rewarded by rising stock prices.

DEREGULATION is the reduction or elimination of government power within a particular industry.  Deregulation is usually enacted to create more competition within an industry.

Deregulation also has brought uncertainty to the power supply business. The result has been an unwillingness to build power plants over the last decade or so. That has kept a ceiling on the supply of power.

Also, we just can’t get enough energy it seems. The more the population grows, the more energy we require. And all this technology we’re using has simply added to energy use.

So we’ve got limited supplies and growing demands, and that makes for higher prices…and likely higher profits for power companies.

Key Learning Points

• When investors talk about utilities, they mean power and phone companies.
• Utilities used to be highly regulated. Because there was a ceiling placed on their profits, their stock prices didn’t offer much potential.
• To attract investors, utilities traditionally paid out a good deal of the money they made to shareholders in the form of dividends.
• The important thing to know about a dividend isn’t the actual amount. The key is the dividend yield – how much you earn from each share as a percentage of the share price.
• Deregulation has meant that utilities can now compete and have the potential to increase their profits. This means that many utility stocks have evolved from being solely income-earning investments (paying high dividends), to investments yielding a lower dividend but having a greater opportunity for their share price to rise.