Are Widow and Orphan Stocks in Vogue Again?
My Favorite Utility Stock
On Friday afternoon, I checked Google Finance to find the following headlines juxtaposed on their front page:
The undeniably good news Friday was that the official unemployment rate has fallen to 5.8%, which is 0.1% lower than in the last report and significantly below last November’s 7.2% rate. The ranks of people who are underemployed and those who want to work but aren’t looking fell too.
However, sharing headlines with the good news was the listless growth in wages, which are barely keeping up with inflation. Other articles got into the potential errors in the numbers, and the Forbes article circled above compared them (unfavorably) with numbers from before the recession. But I won’t get into that here.
The two numbers that matter most to income investors are simply the unemployment rate and the rate of growth in wages. Those two numbers are what the Fed looks at to estimate “tightness” in the labor market, which is one of the prime reasons they might raise interest rates.
From their perspective, Friday’s job’s report was good, but not quite good enough. Or, as Businessweek put it in a Friday headline, “214,000 More Jobs Are Great. But Where Are the Raises?”
As their article explains, “The lack of inflationary pressure from wages gives the Federal Reserve breathing room to keep monetary policy loose for a while longer.
But it’s bad news for Americans whose living standards remain squeezed long after the end of the 2007-2009 recession.”
It’s also bad news for retirees, and other investors who depend on their investment portfolios for some or all of their income, although the reason why is a little different.
The Fed having “breathing room to keep monetary policy loose” may be good for the economy, but it’s lousy for the fixed income markets. As long as banks can borrow from the Fed almost for free, yields on high-quality debt will remain at historical lows. And that means investors who would typically put the bulk of their portfolio in safe Treasury and muni bonds and collect a steady stream of interest payments are either having to settle for a lot less income than they expected, or take on more risk to keep the interest checks flowing.
As I’ve written here before, the better option is to turn to non-fixed-income sources that are actually benefiting from the Fed’s policy. Today, that means equities ... but not all of them.
Overall, the equity market reacted to the jobs report with uncertainty, ending Friday about flat. However, some stocks soared on the news. For some companies, today’s low interest rates and solid economic growth have actually created the perfect environment for growth. They’re happy as clams at high tide, as we say in New England.
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For example, some of the best performers after the jobs report were utility stocks. These staid “widow and orphan” stocks were already having a great run, attracting lots of investor dollars in October as interest rates and the equity market fell in tandem. Compared to bonds and other stocks, utilities offer relatively high yields and low betas. And the party seems to be continuing even as the equity market recovers, with the utility sector overall rising about 1% on Friday.
For utility stocks, today is high tide.
One of my favorite names in the sector is Xcel Energy (XEL), which I added to the Cabot Dividend Investor Safe Income portfolio on October 1. We’re sitting on a 10.5% gain five weeks later, and while a quick profit wasn’t our primary goal here, none of my subscribers have complained.
Here’s part of what I wrote about XEL when I recommended it at the end of September:
“With the stock market giving mixed signals—raising the odds of a correction or simply continued choppy action—we’re adding some stability to our Safe Income portfolio this month with a low-beta utility stock. But we’re not sacrificing income or growth to do it: Xcel Energy (XEL) is an electric utility with operations in thriving areas of the Midwest and West that consistently grows both earnings and the dividend by about 5% per year. Xcel Energy pays quarterly dividends of $0.30 per share, for a yield of 3.9% at current prices.
“Xcel has paid dividends since 1985, and has increased the dividend every year for the past 10. The annual increases tend to be boosts of 5% or less, typical for utilities, which are more focused on consistency than growth. Over the past decade, the annual increases have averaged 4.7% per year. Management has said that its long-term goal is to grow both earnings and the dividend by 4% to 6% annually.
“Combined with the moderate earnings growth predicted by Wall Street, this earns Xcel a Dividend Growth Rating of 7.60 from IRIS [my dividend stock rating system, learn more here]. The utility’s Dividend Safety Rating is even higher, at 9.31, thanks to its long and consistent history of prioritizing dividends.
“While consistent and slowly rising dividends are the number one draw here, Xcel is also a growing company, [thanks mainly to] population growth in Xcel’s service regions, driven by their strong economies. In the last quarter, job growth in Xcel’s service region—which includes Colorado, New Mexico, North Dakota, South Dakota and Texas—outpaced the national average significantly, at 2.3% to 1.8%.”
Today, XEL is 10% higher so the yield is lower, at 3.6%, but I still think the stock is a great bond substitute for investors who want to collect steady income from their portfolios without taking on too much risk. If that sounds like you, I also encourage you to consider joining Cabot Dividend Investor, so you can get my ongoing guidance on XEL plus lots of other income-and-growth ideas.
Sincerely,Chloe Lutts Jensen
Chief Analyst, Cabot Dividend Investor