Categories: Stock Market
Topics: Commodity Stocks

Top Utility Stocks for Investors Seeking Stable Returns and Long-Term Growth

Editor’s Note: Certain stock sectors perform better or worse based on what’s happening with interest rates. Utilities are one of those so-called rate-sensitive sectors. When rates go down, utilities do better. They’ve had a rough two years as the Fed has hiked rates. But with the hiking cycle now done, utility stocks are becoming more attractive once again. Throw in the billions the government is contributing to energy infrastructure, and there is a real case to be made to position in utilities now. I make part of that case below. And I offer specific recommendations in this new video. 

— Nick

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Why are utility stocks a good investment?

Utilities are often a staple of long-term income-generating portfolios because as a sector they pay a higher dividend than the broader S&P 500. 

As of early 2024, the S&P 500 (SPY) was yielding 1.39% and the Utilities Select Sector SPDR (XLU) was yielding 3.32%.

Utilities are also often considered “defensive,” meaning they are better stores of value during times of slow or negative economic growth and/or rising inflation. 

They are, like REITs, considered a “rate sensitive” investment. That is, utilities tend to do better in a low- or falling-interest-rate environment as opposed to a high- or rising-interest-rate environment. 

As such, XLU has far underperformed the broader S&P since the Fed started hiking rates in March 2022.

Investors with a long-term time horizon will note that the only other times the utility sector has pulled back so sharply were during the dot-com bust, the global financial crisis, and the COVID crash. Each of those times proved advantageous to acquire shares with long-term income in mind. 

The current rate-hiking cycle, coupled with billions in government energy infrastructure spending, presents a similar advantageous opportunity. 

How to choose the best utility stocks?

The easiest and safest way to select the best utility stocks is to let the index do it for you. 

Utilities are one of the eleven sectors of the S&P. As such, it has its own sector index, called the Utilities Select Sector, that is weighted by market cap. It includes 30 utility stocks. The Utilities Select Sector SPDR ETF (NYSE: XLU) then tracks the return of this index. As of this writing, the utilities ETF top holdings by weight were: 

This list is a good place to start hunting for individual utility stocks. 

If you’re looking for a proven history of paying and increasing dividends, you might look to see which of the 30 utility stocks in the Utilities Select Sector index are also Dividend Aristocrats. That list is short, and only includes three utility stocks: 

• Atmos Energy (NYSE: ATO)
• Consolidated Edison (NYSE: ED)
• NextEra Energy (NYSE: NEE)

You can also separate utility stocks by their subsectors, of which there are five. Here are those five utility subsectors along with their weight in the broader utility index and their biggest individual constituent:

If you’re into ESG or including carbon in your investment decisions, you could also check out the generation mix of individual utilities to see what their reliance is on fossil fuels, or simply invest in the renewable electricity producers subsector. 

Utility Stock ETFs

There are four ETFs that are linked to the S&P Utilities Select Sector Index. They are: 

• Utilities Select Sector SPDR ETF (NYSE: XLU)
• ProShares Ultra Utilities (NYSE: UPW)
• ProShares UltraShort Utilities (NYSE: SDP)
• Direxion Daily Utilities Bull 3X (NYSE: UTSL)

Note that XLU is meant to track the exact performance of the underlying index while the others are leveraged or inverse ETFs. 

There are other utility stock ETFs that track other utility stock indexes. 

The Vanguard Utilities ETF (NYSE: VPU), for example, tracks the MSCI US Investable Market Utilities 25/50 Index. 

And the iShares U.S. Utilities ETF (NYSE: IDU) tracks the Russell 1000 Utilities RIC 22.5/45 Capped Index.

You'll find the holdings of most of these utility ETFs to be similar, so you should also factor in the expense ratio of the fund when making purchase decisions. 

Risks of investing in utility stocks

The biggest risk to investing in utility stocks is potentially missing out on the higher capital appreciation of other sectors or the broader S&P. Simply put, the underlying stock prices of utilities don’t typically go up as fast as the broader S&P or sectors that fetch higher revenues and earnings multiples, like technology. This is because utilities pay a larger portion of their earnings to shareholders in the form of dividends. 

There is also opportunity cost to owning utility stocks when the economy is accelerating in terms of GDP. During economic expansions, there are other sectors that can deliver better capital appreciation than utilities, like tech and consumer discretionary. 

And as mentioned at the beginning of this article, you should also keep an eye on the interest rate environment when investing in utility stocks. Periods of easing or low interest rates are more favorable to utility stocks than periods of tightening or high interest rates. 

For long-term investors who aren’t worried about market timing, there is never a bad time to invest in utility stocks. 

For those who are more into market timing or actively managing their portfolios, the end of a rate hiking cycle like we are approaching is a great time to get familiar with the best utility stocks - especially in an election year with ample government spending going to energy.

Call it like you see it,

Nick Hodge
Publisher, Daily Profit Cycle