In October of 2023, American Electric Power (AEP 0.49%), also known as AEP, increased its quarterly dividend by $0.05 a share, taking it from $0.83 to $0.88. That's a roughly 6% hike. What's important about that dividend move is that it lives up to a key management promise to dividend investors.
Here's what you need to know.
AEP is an attractive yield story
Although a 4.1% dividend yield may not stack up against a virtual no-risk certificate of deposit (CD) offering as much as 5%, that doesn't mean investors should pass on AEP. The big benefit of a reliable dividend stock over a CD is that the interest a CD pays won't grow over time while a company like AEP can, in fact, increase its dividend -- just like AEP announced in October.
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That increase, as noted, was 6%. Although inflation is high today, the 6% hike from this utility outpaces the historical growth rate of inflation, which is closer to 3%. In other words, the buying power of AEP's dividend will grow over time if it keeps expanding at 6% a year.
And there's another fact here that is relevant. The average utility, using the Vanguard Utilities ETF as a proxy, is roughly 3.5%. Investors are picking up a half a percentage point in yield if they opt for AEP. On an absolute level, that may not seem like much. But from a percentage point of view, that's a huge 14% bump in the income that dividend investors are collecting.
So far the story is pretty strong, but the real question is, what happens in the future?
AEP is leveraging clean energy to grow
As a regulated utility, AEP will never be all that exciting. It has a monopoly in the markets it serves, which is good, but it has to get its rates and capital spending plans approved by regulators, which puts a cap on growth. The best that investors can really hope for is slow and steady.
Only there's a big transition taking place in the utility sector, as companies like AEP shift away from dirtier fuels (like coal) and toward cleaner alternatives (like renewables). This is, in fact, a big part of the long-term plan for AEP, which is hoping to get to net zero emissions by 2045. And don't get distracted by the company's sale of its non-regulated renewable assets. That move was made so that AEP could focus its efforts on building solar and wind power projects for its own use, not to sell power under long-term contracts to others.
There's a big difference between the two approaches. Contracted power deals are negotiated competitively, which can lead to less-than-desirable terms. Regulated clean energy assets are approved by the government and bring with them, effectively, guaranteed returns. They also provide the backdrop for getting customer rate increases approved. Indeed, regulators have to ensure that regulated utilities earn a fair return or the utilities won't be able to attract the capital they need to provide reliable service.
This big energy transition backstops AEP's projections for 6% to 7% earnings growth over the foreseeable future. But the really interesting fact for dividend investors is that management has promised to increase the dividend in line with earnings growth. Note that the 6% dividend hike just announced is right in line with the projected earnings growth.
A worthwhile deep dive for dividend investors
Utility stocks are generally considered safe and reliable dividend stocks. AEP fits that bill. Even though it won't excite you, it could provide a solid foundation for a more broadly diversified income portfolio. Now add in the fact that the dividend yield is toward the high end of the stock's 10-year yield range and it looks like now could still be a good time to buy it. Don't let this opportunity slip by, do a deep dive investigation today.
