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Utilities Stocks Find Favor as Investors Reach for Dividends

Matt Krantz; USA Today  mattkrantz

Q: What's the best way to evaluate utility companies and determine which are best to invest in?

A: Utility stocks used to be so solid that they were considered safe enough for widows and orphans. The industry's steady dividends and stable financial performance was perfect for those kinds of investors, who couldn't afford to take much risk.

With utility deregulation came a lot of uncertainty. But now, an increasing number of investors, interested in dividends, are looking again at utility stocks.

Your inclination to expect something different when it comes to utilities is correct. You're not looking for firms posting large increases in earnings or revenue growth.

With utilities, you're usually in search of stability and financial strength. You want the company's earnings to remain steady during good times and bad. And you want to know with some certainty that the company can afford to continue paying its dividend.

To start, examine the company's dividend yield. The dividend yield tells you what kind of return to expect on your investment from these periodic cash payments.

Searching the 33 utilities in the Standard & Poor's 500 index, we find that the firms with the highest dividend yields recently, according to Standard & Poor's Capital IQ, were:

Progress Energy, PGN, 6.29%
Pepco Holdings, POM, 6.36%
Ameren, AEE, 5.95%
Nisource, NI, 5.76%
Duke Energy, DUK, 5.81%

But you shouldn't rush out and invest in these utilities just because of their dividend yields. You should next consider the payout ratio, which is the percentage of a company's earnings that it pays out in the dividend.

That ratio should be comfortably below 60% or so, meaning the company is paying out little more than half its income, or less, to fund the dividend. Remember that utilities are capital intensive, meaning they invest a lot to keep up and improve their facilities. Pepco, Nisource and Duke Energy all have payout ratios above 100%, meaning they pay out more in dividends than they earn. That's possible because depreciation, while charged against earnings, doesn't require the company to pay out cash; but a high payout ratio usually isn't sustainable for long.

Some of the utilities in the S&P 500 with the lowest payout ratios, according to S&P's Capital IQ:

Questar, STR, 22.3%; with a 1.2% yield.
Sempra, SRE, 30.5%; 3.1% yield.
CMS Energy, CMS, 40.8%; 3.84% yield.
Wisconsin Energy, WEC, 41.3%; 3.21% yield.
Entergy, ETR, 46.9%; 3.69% yield.

You need to consider demographics, too. Utilities are stable businesses because people pay for electricity, water and gas even during a recession. But where you might be in for some trouble is if the area the utility serves is losing population. Fewer people means less revenue spread over the same cost base.

And if there's one thing utility stocks have in common with others, it's the importance of profitability and cash flow. You'll want to take a look at the traditional profitability and cash flow measures to make sure the company is getting an adequate return for the investment it's making in infrastructure. You can learn more here about how to analyze a company's cash flow.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at

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