The major sectors that any investor will invest in are healthcare, consumer goods (food, clothes, and other life essentials), technology, finances, communications, infrastructure, and energy. Those last three groups are a complex mix of different types of companies, many of which overlap. A number of firms in those spaces offer a variety of services and can be classified as belonging to one more than the other, but these companies are usually referred to in one lump group known as “utilities”.
These companies are often low-to-no growth firms who serve an extremely important but limited function in society, and whose value is expected to remain steady as the firms embrace technologies that make them more efficient, but don’t necessarily totally disrupt the market. For a closer look, let’s look at some examples.
Types of Utilities
Traditionally, utility stocks simply meant energy providers; companies like Duke Energy (DUK), Southern Company (SO), NextEra Energy (NEE), and Consolidated Edison (ED) provide the energy that economies need to function. These companies serve local markets with a stable supply of electricity and energy, which means that they are generally slow-growing but reliable stocks with a relatively low risk profile and a shallow downside in most analysts’ models.
These days, information has become as important to daily life as energy once was, so telecommunications stocks have become de facto utility stocks. Companies like AT&T (T), Verizon (VZ), and Sprint (S) are the big three for America, with France Telecom (FTE), Detusche Telekom (DTEGY), and Vodafone (VOD) being the major telecom companies in Europe. Note how some of these companies are very old and established (T, FTE), while some were considered growth-oriented upstarts not too long ago (VOD, VZ). Telecommunications is an interesting group of utilities, because what was once considered cutting-edge technology (cellular phones) has quickly become a staple, transforming just about every company in this sector. After this disruptive technology established itself, telecommunications stocks regained their mantle as reliable, low-growth dividend yielders.
Cyclical Trends
To get a sense of how utility stocks perform, a simple thought exercise is telling. When economies slow and consumption falls, people tend to use less energy. Less purchases from consumers requires less energy for production, meaning less demand for utilities. Fewer deals involve less communication, meaning less demand for telecommunications services.
These changes are incremental and often ancillary to larger technological disruptions that increase inventory (in the case of energy) and bandwidth (in the case of telecommunications). Thus telecommunications and energy providers see their stocks fall in times of economic hardship, but usually less severely than the broader market. Both sectors tend to be less volatile than the broader market, and in the short-term sometimes see lower falls relative to a broader market crash as they are considered safe havens relative to more growth-oriented sectors such as technology.
Dividends and Capital Gains
Investors almost never buy into these sectors with the goal of capital gains, mostly because gains are quite small in these sectors. To get a sense of this, look at the price appreciation of XLU and IYZ over the past ten years–they’ve gone up 90.78% and 26.83% in total in the past decade (in comparison to 66.35% growth for the S&P 500).
Much more important, in the long term, is dividends. Utilities and telecommunications stocks offer big dividends that usually increase steadily over time. The dividend yield for XLU is around 4%; IYZ offers around 2.5%.
The high dividends of telecommunication stocks causes them to trade within a relatively narrow band; VZ’s dividend yield ranges between 4-6% as the market fluctuates, meaning its stock price stays in the same general range ($35 to $45) over time. T is also limited in price fluctuations, with the stock staying in the $30-$40 band throughout almost all of the last decade. The only exceptional period was the late 1990s, when the company got caught up in the dot com bubble.
For most value-oriented investors, this is a distraction to the real prize: dividends. Utilities and telecommunication companies regularly increase dividends; if they don’t, investors grumble, and the stock is at risk. AT&T, for instance, has a current quarterly dividend of 45 cents, up about 140% from a decade ago. The real power of these stocks is the dividend yield on cost, which improves over time.
Conclusions
Since there is a limited price band for utility stocks yet they offer attractive dividend yields and are presumed to have a stable and slowly growing demand for their product, energy and telecommunication stocks in the utility sector tend to be traded similarly: as reliable but low-growth investments that will provide a steady and steadily growing income with limited risk, but also without the tremendous growth potential that stocks in more volatile fields offer.