In this week’s episode Josh and Austin are talking about the most sexy sector of the stock market – drum roll please… Utilities! Throughout this episode the guys run through what exactly a utility stock is, describe the different ways to invest in utilities, and detail the risks and benefits that come along with them. Listen in now!
Main Talking Points
[0:37] – What is a Utility Stock?
[1:39] – Regulated Utilities
[3:11] – Benefits of Owning Utility Stocks
[4:42] – Risks of Owning Utility Stocks
[6:46] – How Treasury Yield Curve Changes Impact Utility Stocks
[10:08] – Dad Joke of the Week
[13:56] – Price Returns
[16:19] – How to Invest in Utilities
[19:59] – Should You Invest in Utilities?
Links & Resources
Invest With Us – The Invested Dads
Free Guide: 8 Timeless Principles of Investing
ETFs vs Mutual Funds – The Invested Dads
Social Media
Full Transcript
Intro:
Welcome to The Invested Dads Podcast, simplifying financial topics so that you can take action and make your financial situation better, helping you to understand the current world of financial planning and investments. Here are your hosts, Josh Robb and Austin Wilson.
Austin Wilson:
All right. Hey, hey, you, welcome back to The Invested Dads Podcast, the podcast where we take you on a journey to better your financial future. Today we’re going to be bettering your financial future by talking about the most sexy sector of the stock market. And that is utilities.
Josh Robb:
Yes.
[0:37] – What is a Utility Stock?
Austin Wilson:
So let’s fifty thousand foot this right off the bat. So Josh, what is a utility stock?
Josh Robb:
Yeah. Well, as you remember, way back in the day, one of our early episodes, a stock is ownership in a company. So-
Austin Wilson:
Boom.
Josh Robb:
When we’re talking about-
Austin Wilson:
Being an owner, not a loaner.
Josh Robb:
Utility stock, that’s right. When talking about utility stocks, utility sector is looking at companies that provide electric or gas use in either for residential or commercial use, but utilities, if you think about if you own or rent your home, you pay utility bill, you to have electric gas.
Austin Wilson:
Oh, I pay them.
Josh Robb:
That’s what we’re talking about. The companies that provide that gas or electricity. So that’s where we’re at. Utilities usually have some sort of steady and consistent stream of income, because again, they are providing a source of energy that is needed for people on an ongoing basis. More often that have a decent dividend yield because of that entity is a consistent cashflow for them and they tend to be on the more defensive end of the side. And we’ll get a little more detailed about some of that.
[1:39] – Regulated Utilities
Austin Wilson:
So when it comes to utilities, I’ve heard the term regulated come up a lot. And I think that we should probably also talk about what that means. So regulated utilities as it relates to specifically publicly traded companies here, these companies, since they are providing a necessary service for customers. So it’s necessary for warmth and life in many instances, it’s just, it’s part of life. And because it’s a necessity, the government feels that it… They have some sort of responsibility to regulate these companies in this area of the market who provide these services to make sure that they’re providing them at A, reasonable prices and B, that they can’t price hike crazy.
So if I were a utilities company, so specifically here in Findlay, most of us probably have AEP, American Electric Power. If they want to have a rate increase. So you’re paying X dollars per kilowatt hour or whatever, if they want to increase that they have to go through a full approval process to get that rate increase approved because it’s a regulated utility.
Now there are certain areas of the country and definitely certain areas of the world outside of the US with unregulated utilities. And those companies can essentially do whatever they want. That’s not the case in most areas around here. So regulated utilities, but it’s that regulated area. It’s because those, the rates are regulated that those companies have such predictable cash flows in revenues.
[3:11] – Benefits of Owning Utility Stocks
Austin Wilson:
So let’s dig into the benefits. So benefits of owning utility stock. Like you had mentioned before, these are steady stable companies, predictable. They have great dividends and they can pay those great dividends because they have those recurring revenues that are very easy to forecast because there’s not a lot of fluctuation there and it’s always in demand.
Josh Robb:
And when you talk about regulated, part of the why there is that stability is there’s not a lot of new companies starting up saying, “Hey, I’m a new utility.” Because the government is regulating it.
[4:42] – Risks of Owning Utility Stocks
Austin Wilson:
That there are barriers to entry to get into UDL. The utility companies that are around have been around for a little while and they’ve merged and done whatever. But generally speaking, everyone… We’ve had power for over a hundred years across the country, so that’s kind of there.
So that is one of the benefits of utility companies. Also, historically speaking, they have lower volatility. Like Josh mentioned, they’re a bit more on the defensive end of stocks that does not mean they have no volatility. Because they are stocks, they are publicly traded companies that you have an ownership in. And just like all of them, whether that’d be the mega-cap tech companies or the defensive utility stocks, they are volatile. And you’re getting compensated in additional return over a bond essentially because of the risk that you’re taking on, the risk that it could go down. And we saw utilities companies last spring, 2020 in March, they didn’t go down as much as the market, but they still sold off. And that’s typically how it works in terms of market volatility. Josh, talk a little bit about the risks. So flip side of that coin, the risks of owning utility stocks.
Josh Robb:
Yeah. So if you think about what the utility companies are doing, they’re providing that energy. So they got to create that energy through different sources. And so one of the risks is weather. So if they have an issue and a good example of that would be Texas. It had that cold front move through with some freeze and that affected their utilities. People were without power for a while because the utility companies weren’t prepared-
Austin Wilson:
They were not ready.
Josh Robb:
Another one just weather in general, super hot. If there’s a high demand for utility they may not be able to keep up with the supply demand. And so then they may be rolling brownouts or blackouts and those types of things. So that’s one risk is if they have that problem, then the shareholders are going to have a problem-
Austin Wilson:
Exactly.
Josh Robb:
… with that. And then another one is when you look at stocks and you’re investing and people usually think of growth when it comes to stocks, they’re kind of conservative when it comes to the stock market world. And so talk about this a little more interest rates play into how utilities do.
Austin Wilson:
Exactly.
Josh Robb:
They are a little more effected by utility movement of price because of interest rates. And so-
Austin Wilson:
We’ll talk about that.
Josh Robb:
We will get into that, but that is a risk for investors when they think about that. And then you mentioned regulation. So when the government is involved, they could pass laws or change things or deny price increases, which would affect the future growth and dividend of a utility. And then on the other side, deregulation could impact competition and things like that. So there are those utility risks as well. And then they have to create the energy.
Austin Wilson:
Oh yeah. What do you make it out of?
Josh Robb:
It comes from somewhere. There are some issues from a global warming standpoint, ESG, how they create that coal being a good example. Coal plants are not the most efficient when it comes to creating energy, nuclear on the other end, which is very efficient, but can have some side effects if it goes wrong. So, how they make it could be at least you need to be aware of that as the utility stock owner.
[6:46] – How Treasury Yield Curve Changes Impact Utility Stocks
Austin Wilson:
So let’s dig a little bit into… I want to explain how treasury yield curve changes really are going to impact-
Josh Robb:
Oh, boy. It’s going to get crazy.
Austin Wilson:
… utility stocks. So there’s really two main sides of the picture here that we’re talking about of how interest rates essentially, as we’re talking about are impacting utility stocks.
So number one is that utilities and REITs also, I’m going to lump those in there. Those are kind of known in the market and thought of as bond proxies. So they’re a little bit more safe. They’re a little bit less volatile. They’re not totally safe and they’re not totally not volatile, but they’re viewed as less risky and less volatile. So therefore they’re likened to bonds. Another way that they’re likened to bonds is the fact that they have, as Josh had mentioned, higher dividend yields and higher dividend yields are that income is a function that you see in the fixed income market that’s very sought after.
So as yields rise, so the bond market is selling off. Yields are rising. So that makes bonds more attractive compared to these areas of the market like utilities and REITs, because you can even take even less risk and go buy a bond and get good yield.
Josh Robb:
Yep. And since the bond prices are going down, because rates are rising, you’re buying them cheaper.
Austin Wilson:
Exactly.
Josh Robb:
For a higher future yield.
Austin Wilson:
So it’s all about comparative valuations there. And that makes bonds increasingly attractive to utility stocks, whatever we’re talking about here. The flip side of that also happens, right. So as REITs fall, so bond prices are going up. Interest rates are coming down these areas. So as in utilities, REITs, the bond proxy areas of the market are going to become more attractive because well, they have good yield and you can get that yield that may be more than you can get with a bond, which especially in today’s market is not hard to come by because richest rates are really, really, really low.
Josh Robb:
Super low.
Austin Wilson:
So that’s one side. The other side of how yield affects utilities is interest burden. So these companies, these utilities companies are often borrowing a lot of money to function, and that’s not a bad business model. That’s just how they operate.
A lot of areas of the market actually run a lot on debt because they can take on debt very cheaply and turn it into profit, essentially. So as interest rates rise, the cost of this debt and the debt burden in terms of dollars is going to increase as well. Because they’re issuing new bonds and bonds in utility sector very safe, generally speaking in terms of a credit rating. But that means that the dollars that they’re going to be paying out in interest, it’s going to be a lot higher. So there’s a couple of factors as it relates to the interest rate environment and how that impacts utilities. But yeah, it does have a lot more of an impact than it does in other areas of the market.
[10:08] – Dad Joke of the Week
Josh Robb:
Yeah. And like you said, utility companies a lot of times… They’re the ones responsible for building out the infrastructure. But they do so knowing that they’ll be able to collect back the cost of that, but over time. So they’ll a lot of times they’re issuing that debt to build out the infrastructure and then the government says, “Yeah, we’ll allow you to increase your costs to recoup that over time.” But if they’re issuing debt and that’s changed you’re right, it could or could not be beneficial. So there’s a lot to consider as a owner in a utility section. All right. Let’s take a break. I got a dad joke for you.
Austin Wilson:
Oh Josh, I’ve been waiting all week for this.
Josh Robb:
Oh man, this one’s funny.
Austin Wilson:
You said it’s good. I’ve not gotten a preview of it yet.
Josh Robb:
So you think that a snail, which are notoriously slow.
Austin Wilson:
Oh yeah.
Josh Robb:
A snail would be faster if you remove its shell. It’s not true. They become sluggish.
Austin Wilson:
That’s funny. Okay. So-
Josh Robb:
You know a snail, and a slug.
Austin Wilson:
I know Josh, of course I know what a snail and a slug are.
Josh Robb:
Do you know slugs have internalized shelves?
Austin Wilson:
No.
Josh Robb:
Yeah.
Austin Wilson:
Weird. Not exoskeleton, but skeleton.
Josh Robb:
And they’re all part of the… Related to the-
Austin Wilson:
Slug family?
Josh Robb:
Well, no, they’re Moelis like clams and oysters.
Austin Wilson:
Oh, you eat. Yeah, you eat snails.
Josh Robb:
But I’m saying they’re all part of the same family. It’s just interesting.
Austin Wilson:
So when we had that big flood, the most recent one, I guess let’s specify.
Josh Robb:
Which one?
Austin Wilson:
2000 and maybe 17, I think. We had just bought our house. Never had a big bunch of flood before. Anyway, we ended up getting a lot of water in the basement as most people did at that point. And I remember going out, we had one of those… So we live in a very, very old house and we have one of those basement exits that comes out of the like, like you see on Twister, I think.
Josh Robb:
Oh, the horror movie.
Austin Wilson:
Yeah. So you can get as for tornadoes or what. I don’t know. But anyway, I was opening that thing up to exit out the… Clean out the water and everything. There were 50 slugs on those. Yeah. Once the water had kind of gone down 50 slugs on the steps of my basement entrance. And I don’t know how they got there because they’re not there when it’s dry.
Josh Robb:
No, they sneak in.
Austin Wilson:
They just came out of nowhere.
Josh Robb:
They followed-
Austin Wilson:
They were a little sluggish, but they came.
Josh Robb:
They took a little while to get there.
Austin Wilson:
Okay. So to recap what we were talking about in utilities. A couple of things you get with utility stocks, you get steady, regulated business without surprises. That’s pretty much what you get. Whether it being the biggest wild card, you also get a nice dividend yield. For example, we had mentioned this, that dividends are lucrative and utility as well, putting numbers to it. The S&P 500, sorry we’re using the SPY ETF, yields about 1.26% dividend yield. Really low historically, but also that’s the market in general, 1.26%. the XLU, which is the Sector SPDR ETF. It yields 2.91%. So if you divide that the differences, so 131… The XLU has 131% of the yield of the-
Josh Robb:
You getting more than double.
Austin Wilson:
Yeah. You’re getting more than double, which is a lot of yield. And it’s even that’s low historically for utilities because all of these stocks have gone up, but their prices have gone up faster than their dividends have over time. So the yields look a little bit lower.
But anyway, that is an example. Yeah, you are a lot. So that’s what 2.3% more yield, lucrative. What you don’t get, things we mentioned, you don’t get fast growth, slow and steady wins the race here. Pretty regulated, pretty slow and steady. You also, probably in most instances, don’t get much innovation, utilities, utilities, utilities, utility. However, this has taken a bit of a change lately. As utility companies have been pushing into renewable energy and renewable energy as a kind of new frontier. And our country is moving towards increasing the percentage of our renewables and our total carbon footprint and all that stuff. So it’s kind of a cool, we’re getting some innovation-
Josh Robb:
… yeah wind, solar, water.
Austin Wilson:
We have hydro. Yeah, exactly. And you probably, and we’re going to talk about this in just a second, don’t want to expect exciting returns. Okay. You might do okay sometimes.
Josh Robb:
They’re full of energy.
[13:56] – Price Returns
Austin Wilson:
They’re full of energy. So let’s talk about returns. This is just price returns, is not looking at total return. Total return is going to look a little bit better. It will not change the overall picture, however. So I’m looking as far back as I really can do to the latest month end we’ve got. So I’m looking for from 12/31/98 to 7/30/21,
Josh Robb:
7/30 or 7/31?
Austin Wilson:
7/30 was the last trading day of the month.
Josh Robb:
Oh, that’s true. So weekends.
Austin Wilson:
Exactly. Those weekends. So the S&P 500 as shown, I will be talking about the SPY SPDR, SPY BTF that has returned 255.6% price return over that time. Really good return. The XLU, the same Sector SPDR ETF over the same timeframe has returned 118.2%. That’s a big difference. That’s well over double.
Josh Robb:
Yes. That’ll be a half.
Austin Wilson:
The S&P has returned well over double of the XLU. Now let’s close in in a little bit more and take out part of a bear market. And so we’re looking at the 20 year trailing through July. The SPY up 319.9%, and the XLU up 125.5%. Again, same story. More than double for the SPY. 15, bringing them in five years, 15 year trailing, SPY up 228.3%. The XLU up 94.1%. More than double. Bringing in another five years, ten-year trailing, SPY up 287.5%, XLU up 96.2. That’s about triple, wow. Bringing in another five years, the five-year trailing return, SPY up 102.7%, XLU up 34.7%.
Josh Robb:
That’s a third of the return. That’s crazy.
Austin Wilson:
So like I said, not super exciting returns. Now, what do you notice though? All of those are positive and you get that yield on top of that, which if you’re reinvesting into even the same security or something else as you can set it up to do, you’re going to enhance your returns and you might be getting… I’m sure that that yield started off at 3 or 4% for the XLU. It’s just trickled down over time. But the S&P has also had the same compounding effect. So the difference is pretty drastic. So Josh, you might ask me, Austin-
[16:19] – How to Invest in Utilities
Josh Robb:
I’ll ask you Austin. How do you invest in this sector?
Austin Wilson:
I don’t know. Okay, I do know.
Josh Robb:
I know you do.
Austin Wilson:
There’s a couple of ways. And we talk about this every time, and we’re going to preface this with saying, this is not a recommendation. These are just ways to invest. We’re not saying go invest in these things. Talk to your advisor about that. Look at your individual financial situation. This is not a recommendation, but you can invest in the utilities sector of the market, through stocks, ETFs, or mutual funds. These are some examples we’ll talk about. So speaking of stocks, I took some big names that you may have heard of. The biggest stock by market cap in the utility sector is NextEra Energy. And that is actually one of the most renewable focused utilities in the country. That is one of them. Ticker, NEE, it’s actually had a really good stock chart over the last handful of years, which is unusual for utilities.
The next one is Duk Energy. DUK. That’s a pretty sizable utility as well. Another couple that you may have heard of on top of that Dominion Energy, ticker D just D that’s it. One letter.
Josh Robb:
You get one.
Austin Wilson:
And another one, the one that we have around here in terms of electric provider is American Electric Power ticker AEP. So though, if you’re going to get individual companies, that’s one approach for it. Alternatively, you could look at buying the sector, essentially. So the ETFs or Exchange Traded Funds. And if you don’t know the difference between a mutual fund and ETF, we do have an episode about that and we can link that in the notes below. But the utilities sector, SPDR ETF, that we had been talking about comparing the S&P to ticker XLU, that’s one way to get dedicated, utility sector exposure, market-cap weighted. A lot of these are going to be market-cap weighted.
Another one is the Vanguard Utilities ETF VPU is the ticker on that one. The iShares utilities ETF, IDU is the ticker on that one. There’s a John Hancock Multifactor Utilities, JHMU is the ticker on that one. I think that one’s more of a factor-based like a quant-based utilities ETF. And then if you want to step out of the United States and look at global utilities, the JXI ticker is the iShare’s global utilities ETF.
So then flipping the page to mutual funds, different than ETFs. Like I said. Go listen if you want to hear more about what those are. Looking at mutual funds, there is a popular one I’ve heard of Franklin Utilities Fund. There’s a couple different tickers, obviously with share classes, but one of the tickers is FKUTX on that one, the Fidelity Select Utilities Portfolio that ticker is FSUTX. And then there’s one called the Icon Utilities and Income Fund. And that ticker is ICTUX.
So those last two buckets, ETFs and mutual funds. Those are ways to hold utilities without having the risk of a single stock in your portfolio, which some people really like. You also don’t get the reward of a single stock in your portfolio if it does go your way. That’s kind of the… That’s spreading your eggs in different baskets.
Josh Robb:
And you mentioned there are some utilities that also issue bonds as well, that you could invest in.
Austin Wilson:
True.
Josh Robb:
Which is not owning the stock of that utility. But if you were looking for the debt side of the utility sector, that would be the other one.
Austin Wilson:
And there’s actually also utility bond ETFs and mutual funds. So I was focusing on the equity side here, but you can buy individual bonds from these utility companies. You can buy utility bond ETFs, utility bond mutual fund.
Josh Robb:
Okay.
[19:59] – Should You Invest in Utilities?
Austin Wilson:
Exactly. I’m not going to dig it. There’s a lot, there’s so many different ETFs mutual funds, but yes, you can do that if you so choose. So Josh, the question then becomes, I can invest in utilities. But should I invest in utilities?
Josh Robb:
Well, that’s a good question. And you know my answer to that.
Austin Wilson:
Well, I want you to start with what your answer.
Josh Robb:
It’s always this.
Austin Wilson:
Okay.
Josh Robb:
It depends.
Austin Wilson:
But you probably already own some. That’s probably a good point
Josh Robb:
Yes, yes. So should you own it? It depends. But most often, if you own US stocks in some sort of fashion, there’s probably utility piece in there. So if you have an S&P 500 fund and you kind of diversify the US holding, there’s probably some exposure utilities in there. But if you don’t have that it really just depends on what your goals are.
Austin Wilson:
Absolutely.
Josh Robb:
And what your risk tolerance is and what your objectives and how long you’re going to be investing. Same with anything else. This sector, although it’s unique in the different sectors. It’s no different when it comes to the long-term planning. Is does this give me the best chances to meet my goals?
Austin Wilson:
Absolutely. So, yeah, it depends on your situation. Talk to your advisor, ask them if-
Josh Robb:
Definitely.
Austin Wilson:
… A, if you have some already baked into your S&P 500 index fund or whatever, or B, if you should add some kind of depends on the situation. So two things for me, number one, it is not too late to enter our second half stock draft competition. Check the website post that we made, or our social media post that we’ve made, where it tells us all the details of how to do that. But it is not too late, all the way through in the end of the year. So if you want to beat Josh and I at a second act, half stock draft.
Josh Robb:
There’s a good chance you could do that right now.
Austin Wilson:
Have some fun. It’s a good time. A hundred thousand fake dollars are up available for investing. You don’t get to keep anything at the end.
Josh Robb:
You get to keep your username and password that you created to log in.
Austin Wilson:
To use next year.
Josh Robb:
That’s it.
Austin Wilson:
Number two, as always check out our free gift to you. A brief list of eight principles of timeless investing. These are overarching investment themes meant to keep you on track to meet your long-term goals. We don’t specifically talk about utilities. However, like we said, they may be a part of your financial picture already and you just don’t know it. So check that out. It’s free on our website, Josh, how can people help us grow this podcast?
Josh Robb:
Yeah. As always make sure you’re subscribed. That way every Thursday you get the most recent episode downloaded straight for your listening pleasure.
Austin Wilson:
Because we drop it like it’s hot.
Josh Robb:
We do drop it like it is very warm. But we also leave a review at the podcasts place, whether it’s apple or wherever that helps other people find us. And hopefully they’ll be impacted as well and help their financial futures. If you have a question, please shoot us an email@helloattheinvesteddads.com. Also we’d love to hear your thoughts on future episodes. We’re kind of always tailoring this to what the needs are of our listeners. So if you have a question or a thought, shoot us an email. And then last but not least, if you know somebody who loves utilities, make sure you share this episode with them.
Austin Wilson:
Most people. All right, well, until next Thursday, have a great week.
Josh Robb:
Alright, talk to you later. Bye.
Outro:
Thank you for listening to The Invested Dads Podcast. This episode has ended, but your journey towards a better financial future doesn’t have to. Head over to theinvesteddads.com to access all the links and resources mentioned in today’s show. If you enjoyed this episode and we had a positive impact on your life, leave us a review, click subscribe, and don’t miss the next episode. Josh Robb and Austin Wilson work for Hixon Zuercher Capital Management. All opinions expressed by Josh, Austin or any podcast guests are solely their own opinions and do not reflect the opinions of Hixon Zuercher Capital Management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Hixon Zuercher Capital Management may maintain positions in the securities discussed in this podcast. There is no guarantee that the statements, opinions or forecast provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses, which would reduce returns. Securities investing involves risk, including the potential for loss of principle. There is no assurance that any investment plan or strategy will be successful.
