Should utility stocks be at the top of retirees’ buy lists?
Retirees have been favoring these stocks for years, of course, and they have been handsomely rewarded. Over the last 20 years, for example, the Utilities Select Sector SPDR (XLU) has beaten the S&P 500 index (.SPX) by an annualized margin of 6.7% to 6.0%. It’s extraordinary for stocks as conservative as utilities to nevertheless beat the broad market over the long term.
But can we expect this 20-year run of outperformance to continue? To find out, I touched base with Kelley Wright, editor of the Investment Quality Trends newsletter. Wright is well suited to providing insight into this question, since his newsletter focuses on dividend-yielding stocks (including dividends) and sports one of the best long-term track records in the Hulbert Financial Digest ranking.
Over the last 20 years, for example, the Investment Quality Trends’ model portfolio has done far better than either the XLU or the S&P 500, gaining 9.7% annualized. Better yet, the newsletter’s risk—as measured by the volatility of returns—was lower than that of either the XLU or the S&P 500.
Not to bury my lead too much: Wright is not bullish on the sector. “I wouldn’t recommend that investors searching for equity income initiate any new positions in the utility sector right now,” he told me in an interview.
To understand why, it’s helpful to step back and understand his approach to valuing dividend-paying stocks. Wright focuses on “relative” dividend yield—comparing a stock’s dividend to the historical range of its past yields—and considers a stock to be overvalued when it’s trading at or close to the low end of that range.
Consider what this means as it applies to the Dow Jones Utility Average (.DJU). Wright calculates that this Average’s dividend yield in the past has for the most part fallen in the range of 3% to 6%. Its current yield is 3.2%, which Wright says is dangerously close to the 3% yield that indicates extreme overvalue.
In other words, “Most of the utility sector’s value has already been wrung out of it.”
At a minimum when considering utility stocks, therefore, retirees should focus on both their dividend yields as well as their potential for capital gains or losses. That’s because an attractive dividend is of limited solace when the stock’s price is declining.
Wright added that it’s not hard to see both why utility stocks have performed so well in recent years and why they are likely to find an investment environment in coming years that is less hospitable. Utilities are particularly interest rate sensitive, so they benefited greatly from the many recent years of rock-bottom rates. By the same token, however, they will be hurt as interest rates return to more normal levels, as the Federal Reserve has committed itself to bringing about.
If not utilities, which stocks does Wright recommend for yield-hungry retirees? His advice is to seek out those high-quality stocks whose current yields are close to the high ends of their respective historical yield ranges. The “high-quality” part of this advice is important, since you would want to avoid a high-yielding company whose ability to continue paying that dividend is questionable.
The following is a listing of the 10 high-quality blue-chip stocks that are Wright’s top recommendations right now, listed in descending order of their dividend yields:
- IBM (IBM); yielding 5.4%
- Philip Morris International (PM); 5.0%
- AbbVie (ABBV); 4.7%
- Whirlpool (WHR); 4.1%
- PepsiCo (PEP); 3.3%
- Omnicom Group (OMC); 3.2%
- Franklin Resources (BEN); 3.0%
- J.P. Morgan Chase (JPM); 3.0%
- T. Rowe Price (TROW); 2.9%
- Colgate Palmolive (CL); 2.8%
These 10 stocks’ average current yield is 3.7%, which is well above the 3.2% current yield of the 10-Year Treasury (.TNX). And, unlike the situation with utilities, Wright believes these 10 stocks’ upside potential over the next three to five years is far greater than their downside risk.
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