Most of my clients in their 50s and 60s are looking for consistent, stable companies that can survive in this volatile market environment. As they approach retirement, many of these clients prefer stocks that can provide them with additional cash to supplement their pension and Social Security payments. Here at StreetAuthority, we call them Retirement Savings Stocks.
Finding these types of companies involves a lot of digging. I generally look at seven different criteria to evaluate whether a stock is suitable as a Retirement Savings Stock.
It should have:
1. A long track-record of paying consistent and rising dividends.
2. Up-trending earnings.
3. Strong cash flow that's sufficient to keep dividend payments.
4. High projected growth that can lead to dividend increases.
5. Manageable debt loads, so that there's more cash to distribute.
6. Noncyclical business models that can help the company prosper in all market conditions.
7. Strong management team that can make smart decisions to enhance shareholder value.
In this low interest rate environment, I have been recommending that my clients buy dependable stocks with a dividend yield near 5% or higher. In this sense, utility stocks certainly fit the bill.
Utility stocks have become popular during the past few years because of their high yields and consistent returns. But as the Federal Reserve pushed rates lower, even the most conservative investors are now scouring the stock market to chase higher-yielding stocks.
And until short-term rates start to rise again, dividend-paying stocks will keep attracting investors. Even during the slow-growing economy of 2011-12, utility stocks have held up nicely. Take a look at the chart below…
Many assume utility stocks are a safe bet. But from 1927-2011, the stock market provided an annual average return of 11.6%, with an annual standard deviation of 20.5%. Standard deviation measures the amount of volatility an asset experiences. During this same time period, utility stocks had a lower annual average return (11.3%) along with a higher standard deviation (22.2%).
Worse yet, from 1927-2011, there were 16 years when utilities as a group lost at least 10% and 8 years when the entire group lost at least 20%. Utilities are just like any company — they can go bankrupt, or can cut or eliminate their dividends. So investors have to be very careful when selecting a utility stock.
Dividends should be an important consideration, as much of a utilities' earnings are paid out in the form of dividends. But as an investor I want to get paid two ways: through its dividend and capital gain potential (growth). As such, my focus in the utility sector has been on growth opportunities. I seek out utilities that don't rely on customer usage growth, automatic and timely rate-adjustment mechanisms, or low payout ratios.
Here are five utility stocks with the perfect blend of growth potential and income reliability…
1. National Grid (NYSE: NGG)
Aging energy transmission networks and renewable energy requirements in the United States and U.K. are set to fuel the growth for this utility already yielding about 5.5%. These requirements will demand large capital investments, which will likely drive earnings growth for many utility companies.
Companies based in the U.K. such as National Grid have additional advantages. This utility has kept its promise of 8% annual dividend growth through 2012, with an additional 4% increase promised for 2013. As a result, the yield should approach nearly 6% in 2013. This company possesses the rare "perfect" combination of growth and income. Its stock is already up nearly 21% so far in 2012.
2. Brookfield Infrastructure Partners LP (NYSE: BIP)
As a diversified utility, Brookfield has tremendous opportunities in the years ahead. It owns and operates electricity transmission systems and timberlands in North and South America. Brookfield focuses on acquiring infrastructure assets that have low maintenance capital costs and high barriers to entry. Because of its diversified business approach, the company has been able to deliver solid gains (25%-plus annualized returns during the past three years) and a good yield.
3. American Electric Power (NYSE: AEP)
The stock is trading at 13 times projected 2013 earnings. I think it is undervalued, with the industry average trading at 16 times projected earnings, and has exciting long-term growth opportunities. The company's regulated utilities remain the core growth driver, with projected 9% annual earnings growth during the next five years, based on its aggressive capital investment plans. This stock has a great yield and a lot of upside growth potential. Since 2009, this stock is up almost 52%.
4. Westar Energy (NYSE: WR)
Ultralow interest rates and a weak economy have regulators everywhere scrutinizing utility rates closely. But Westar continues to navigate the challenges well, averaging double-digit annual earnings growth since 2008. This stock is already delivering strong yield and impressive growth. Westar has averaged more than 14% a year for the past decade.
5. GDF Suez (GSZ.PA)
With strong growth potential and an appealing valuation, this French energy conglomerate has a diverse, low-cost and well-positioned power fleet. It primarily engages in buying, producing, and selling natural gas and electricity in France and globally.
The company generates electricity from wind, biomass, solar, biogas, hydro, natural gas, coal-fired, fuel oil and nuclear sources. It also engages in natural gas transportation, storage and distribution; and electricity transmission, storage, and distribution. It has great long-term prospects. The stock was hammered with the downturn in Europe, but the valuation is attractive and it has a lot of rebound potential as a contrarian investment opportunity.
Action to Take –> Buy National Grid up to $60 per share. Brookfield Infrastructure is a great buy under $35 per share. Buy American Electric up to $45 per share and Westar Energy for up to $ 31 per share. GDF Suez is a great buy for up to $18.50 per share. These five companies are yielding between 4.5% and 8.5% with great upside potential. Each would make a good addition to any retirement savings account.
— Jay Peroni
P.S. — If you want to find out more about the best stocks to own for your retirement, then go here to read the latest report, "The 10 Best Retirement Savings Stocks for 2013," which tells you more about Retirement Savings Stocks, including the names and ticker symbols.
This article originally appeared on StreetAuthority
Author: Jay Peroni
5 Utility Stocks with the Perfect Combination of Growth and Income