Guest Post by Tom Hutchinson, Chief Analyst, Cabot Dividend Investor
Many view dividend stocks as boring investments that your grandfather talked about while he smoked his pipe and pulled up his trousers.
But that isn’t true. Dividend-paying stocks as a group have vastly outperformed non-dividend payers over time. The dividend contribution, along with the quality of companies that can consistently pay dividends, delivers stellar results over time. The big returns are there, too. In fact, four of the “Magnificent 7” stocks are dividend payers.
Of course, the negative stereotype isn’t far off with utility stocks. They are boring, grandfatherly stocks.
Utilities are companies that provide water, energy, and electricity to homes and businesses. They operate monopolies or near monopolies in their areas, and the rates they charge are usually determined by regulatory bodies.
They usually pay strong dividend yields and provide highly defensive earnings that continue in any kind of economy.
As a result, utility stocks tend to have high dividend yields, with consistent dividend growth over time.
You can download the list of high dividend stocks (along with important financial ratios such as dividend yields and payout ratios) by clicking on the link below:
But, aside from the dividend and defensive characteristics, they’ve typically offered little else. Good stocks tend to outperform the indexes in flat or down markets and underperform them in bull markets. They are the market sector that most closely resembles bonds.
That’s not necessarily a bad thing. Utilities offer diversification and stability to a portfolio. Markets don’t always go higher. It’s nice to have utilities in the portfolio when other stocks sputter. They make the ride to longer-term success easier and less bumpy.
But utility stocks are morphing into something else as the world rapidly transforms. After being stagnant for decades, electricity demand is exploding. Artificial intelligence (AI) requires enormous amounts of electricity for the data centers that house the computer components. Electric vehicle proliferation and rapidly growing onshoring of manufacturing are also juicing demand.
AI is transforming the utility sector. Now, the best utility stocks boast everything that I mentioned above, plus a lot more. Skyrocketing demand is making electric utilities growth businesses as well.
The changing environment is adding another hugely positive dimension to these underrated stocks. And there is still time to get in ahead of the pack. The combination of defense and growth is the best of both worlds.
NextEra Energy, Inc. (NEE)
NextEra Energy (NEE) is the nation’s largest producer of renewable energy and the largest utility in the country. It should be in an ideal position to benefit going forward.
NEE has historically been a superstar performer for a utility. But it has stumbled in recent years as inflation and rising interest rates made utilities an out-of-favor sector. But things are changing. NEE has been trending higher since April. But the price is still 25% below the all-time high.
NEE isn’t just some boring, stodgy utility stock with the possible benefit of good timing. It has a long track record of not only vastly outperforming the utility sector but the overall market as well. Prior to 2023, NEE total returns more than doubled those of the S&P 500 in the prior five- and ten-year periods.
How could a utility stock provide such returns? NextEra is not an ordinary utility.
NextEra Energy provides all the advantages of a defensive utility plus exposure to the fast-growing and highly sought-after alternative energy market. It’s the world’s largest utility. It’s a monster with about $26 billion in annual revenue and $155 billion market capitalization. Earnings growth has far exceeded what is normally expected of a utility.
NEE is two companies in one. It owns Florida Power and Light Company, which is one of the very best regulated utilities in the country, accounting for about 55% of revenues. It also owns NextEra Energy Resources, the world’s largest generator of renewable energy from wind and solar. It accounts for about 45% of earnings and provides a higher level of growth.
NextEra is the best of both worlds: defense and growth. There is also a huge runway for growth projects. NextEra has deployed over $50 billion in the last few years for growth expansions and acquisitions. It also has a large project backlog.
As the country’s largest producer of clean energy, NextEra has a huge advantage going forward. The skyrocketing growth in electricity demand is primarily driven by data centers and AI. Technology companies are highly carbon-conscious and will opt for clean energy alternatives whenever possible to reduce their carbon footprint.
American Electric Power Company, Inc. (AEP)
American Electric Power is one of the largest regulated utilities in the U.S. with over $20 billion in annual revenue. It provides electricity generation, transmission, and distribution to 5.6 million retail and wholesale customers in 11 states.
The utility currently generates 29 gigawatts (GW) annually. A gigawatt is a unit of power equal to one billion watts of electricity and is often used to describe large-scale electricity generation.
Although the electricity generation is significant, American earns the bulk of revenues from transmission and distribution. It has the largest transmission network in the U.S. with 40,000 transmission lines. It also operates the second-largest distribution network in the country, covering 22,000 distribution miles and 5.6 million customers. The overall system currently deals with a total of over 37 GWs of electricity.
The transmission business is a distinguishing characteristic of American Electric Power, currently accounting for 55% of operating earnings. Customers are drawn to its services because of its advanced network capable of delivering consistent large power. The company owns more of the highest-voltage transmission lines (765-kV lines) than all other U.S. utilities combined. These lines transmit huge amounts of electricity, primarily bulk power from generation sources to distribution centers, over long distances with far greater efficiency and reliability compared to lower voltage lines.
The network of high-voltage lines is in high and increasing demand because of rapidly growing needs for massive amounts of electricity that can be moved around cheaper, faster, and more efficiently. The network is also highly difficult to duplicate by competitors. Building these lines requires agreement between utilities, regulators, and landowners with competing interests and can take huge amounts of time and costs to erect.
Historically, AEP has been a solid utility stock that delivered as advertised. It has provided a strong dividend yield with much lower volatility than the overall market. It has a beta of just 0.39, meaning it is only 39% as volatile and the S&P 500.
It generally did what utilities are supposed to do: Outperform the S&P in flat and down markets and underperform it in bull markets. But there are good reasons to believe that performance could be much better going forward because of a much higher level of growth.
Greater growth is being driven by the rapidly increasing electricity demand in the country. The growth isn’t conjecture either. American has already secured an additional 24 GWs of incremental load growth through 2029 with signed customer financial agreements.
About 75% of the demand is from data centers. That’s a big increase to the current 37 GW system. About 75% of the demand is from data centers. And this is just the beginning. The utility said that it has inquiries about new load demand totaling 190 GWs.
Both of these utility stocks have a powerful AI-fueled tailwind at their back and look poised for continued outperformance.
Additional Reading
You can see more high-quality dividend stocks in the following Sure Dividend databases, each based on long streaks of steadily rising dividend payments:
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