If you are a looking at utility stocks, you probably have a preference for collecting dividend checks. On that score. Consolidated Edison, Inc. (ED 1.15%), El Paso Electric Company (EE), and PPL Corporation (PPL 0.53%) have all proven they know how to take care of investors. But they also have another thing going for them, a tool created by Benjamin Graham, the father of financial analysis and the man who helped train Warren Buffett, suggests they look like good deals. Here's what you need to know about this trio of stocks today.
1. Dividend bonafides
One of the key reasons why investors buy utility stocks is that they pay dividends. Con Ed's yield is a robust 3.7%, El Paso's is comparatively low at 2.5% (though this is still above the roughly 2% yield offered by the broader market), and PPL's yield tops the list at around 5.4%. Con Ed, meanwhile, has increased its dividend annually for an incredible 44 consecutive years. PPL's streak is up to 17 years and El Paso's is at a respectable eight.
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With regard to dividend growth, Con Ed and PPL have been increasing their dividend payments at or a little above the historical rate of inflation growth (around 3%) while El Paso's dividend has grown at an annualized rate of roughly 6% over the past five years. So the buying power of the dividends that investors receive from Con Ed and PPL have remained steady over time, but El Paso shareholders have seen their buying power expand nicely. Investors are usually willing to pay more for utilities with higher dividend growth rates, which helps explain the lower yield at El Paso.
All of that said, this trio sells something that modern society simply can't live without -- power. And they have government granted monopolies in the markets they serve (the trade off is that regulated utilities need to get rate increases approved by their regulators, more on this below). The takeaway is that they have very consistent businesses that can support their dividends in good markets and bad. Even if the stock market is facing headwinds or the economy falls into a recession, Con Ed, El Paso, and PPL are highly unlikely to see demand fall off a cliff.
2. The value proposition
Dividends alone don't tell the whole story, which is where the Graham Number steps in. This is a short-hand tool that creates a value to which you can compare a company's price to quickly get a handle on its valuation. Here's the math: Multiply earnings per share by book value per share. Multiply the resulting number by 22.5, which corresponds to an earnings multiple of 15 times -- a number that Graham believed was fair. And then take the square root to come up with a dollar and cents figure. According to Graham this is what a reasonable person would be willing to pay for a company.
You can do that math or you can just look at the Dividend Champions, Challengers, and Contenders list provided by the DRiP Investing Resource Center. Although the list doesn't show the actual Graham Number, it shows where each of the nearly 900 reliable dividend payers on these lists sit relative to that number on a percentage basis. Right now, Con Ed, El Paso, and PPL are have desirable Graham numbers. PPL is hovering around its Graham number, which suggests it's fairly valued today -- for income investors a higher valuation is probably a worthwhile tradeoff for PPL's lofty yield. El Paso is around 25% lower than its Graham number, and Con Ed is a whopping 50% under its umber. So all three look relatively desirable today when you look at this shorthand valuation tool.
3. What about the future?
But good dividend records and a modest valuation isn't really enough, either. These three utilities have reliable businesses, but what about future growth? Growth, to a large extent, is in the hands of regulators... Which is not nearly as bad as it sounds. That's because utilities get spending plans approved and then execute them over multi-year periods.
Rate hikes generally follow based on execution of the plan, and sometimes hikes are approved before all of the spending is complete. Regulators like to see spending on things like new capacity, upgrading infrastructure like power lines, and integrating high-tech efficiency equipment like remote meter monitoring. All three of these companies are focused on just such spending today.
PPL's high yield is partly a function of the fact that it's power is largely provided by dirty coal power plants. However, it wants to reduce its CO2 emissions by 70% (from 2010 levels) by 2050. That's going to require a lot spending on cleaner capacity options, which is exactly the type of spending that regulators like. PPL is currently planning to invest roughly $15 billion in its business between 2018 and 2022. And all of that should take place regardless of what happens in the stock market. So, in this case, dirty coal is something of a benefit if you are looking for a decent price on a high yield stock with highly predictable growth potential.
ED Dividend Per Share (Quarterly) data by YCharts
Con Ed, meanwhile, is expecting to spend around $12.5 billion between 2018 and 2020. The investments this New York City focused utility is making, meanwhile, are going towards things like smart meters, storm hardening, and upgrading aging infrastructure. Again, these are the types of things that regulators like to see. Con Ed is projecting 6% annualized rate base growth through 2020 -- which should take place even if the stock market is gyrating up and down.
El Paso's capital investment plan calls for $1.5 billion in spending between 2018 and 2022. The spending will go toward things like new generation (such as solar), transmission, and distribution. All of which will make regulators and investors happy. But what helps differentiate El Paso from Con Ed and PPL, is that the Texas and New Mexico regions it serves are growing faster than average. For example, its customer base has grown at nearly twice the rate of the overall industry and usage per customer at El Paso has increased while the average for the utility industry is a slight decline. These trends underscore the need for more capital spending. And all of this has led to higher dividend growth over time, which helps to make up for the lower starting yield here.
A solid foundation
If the market's volatility and still high valuation have you worried about the future, you should step back and consider adding some boring, dividend paying utilities to the mix. Con Ed, El Paso, and PPL all fit the bill and they all look relatively cheap today, using the Graham Number shortcut. Meanwhile, their regulator approved spending plans should continue to drive results no matter what happens to the broader market. If you are out for yield, start with PPL. If you favor dividend growth, then El Paso might be the right for you. And if you are into value investing, then the Graham Number suggests that Con Ed might be up your alley.
