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Three Reasons Why Now is a Great Time to Buy Utility Stocks

In a challenging economic environment, scores of investors crave what feels safe. For many investors, it's utility stocks.

Indeed, these equities have even garnered the moniker "widow-and-orphan stocks."

Simply put, people put their trust in utility stocks. They have long been a safe traditional option that also enables investors to capture high dividends.

Another benefit is they deliver essential services such as water, gas and electricity-which are always in demand no matter what shape the economy is in.

That's why the sector tends to be one of the more stable areas of the stock market in terms of daily performance.

The truth is utility stocks are also apt to hold up better in declining markets and anemic economies since investors are more comfortable sticking with lower risk investments.

Since utility stocks also typically pay above market dividends that makes them one of the best defensive investments in the market.

In fact, over the last decade, the Select Sector SPDR Utilities (NYSE: XLU), whose holdings span the entire U.S. utility sector with a concentration on the largest companies, has typically carried a yield 1.75 to 2.5 times that of the S&P 500 Index.

What's more, it's done so with a lower level of volatility than the overall market.

With markets on a tear, and more and more companies paying hefty dividends, utility stocks have lost a bit of their appeal. The sector is off some 10% since its late April highs due to a broad market selloff.

The rout leaves the sector up roughly 8% year-to-date, which is enticing compared the Dow's 16.36% rise, the S&P 500's 15.23% gain and the Nasdaq's 14.89% increase.

Why It's Time to Buy Utility Stocks

But that not the only reason to buy utility stocks. Here are three other good reasons to invest now:

    1. Low interest rates

The utility sector turns in its best performance when interest rates are low. It's not simply because income hungry investors flock to high yielding dividend stocks; it's because utility stocks are traditionally highly leveraged-meaning they require large amounts of capital. High interest rates chip away at utilities' profits.

The Fed pledges to keep interest rates at rock bottom levels until unemployment dips below 6.5% and inflation remains under 2.5%.

By some estimates, low rates are safe for at least two more years.

    2. A Safe Haven of Sorts

Based on stock market history dating back to 1929, the current bull market is looking old. The average bull market period runs 31 months, with the average frequency every 3.4 years.

The present bull market is 50 months old, which means this bull market is long in the tooth at 4.2 years. The best gains may already have been logged, and finding the next big winners will be a challenge.

Meanwhile, old-school utility stocks provide portfolio protection with reliable passive income.

The average utility dividend of 4% is roughly double that of the S&P, and higher than every major industry group except telecoms, Barron's notes.

    3. They're Out Of Favor

Market participants' current biggest anxiety is the fear of missing out on rallies. In the dash for big gains, conservative utilities have been overlooked as investor chase yesterday's winners at today's high prices.

That's one reason to buy utilities now. Steady profits, solid dividends and strong performance when the economy sours are others.

Utilities Stocks to Consider

A fresh sign of opportunity in the sector flashed when Berkshire Hathaway (NYSE: BRK.A) shelled out $5.6 billion to buy electric company NV Energy Inc. (NYSE: NVE).

Nevada's largest utility will join MidAmerican Energy Holdings in Berkshire's energy subsidiary. The big bet fits CEO Warren Buffett's criteria for an investment: it's a business easily understood; it's a relatively safe investment; and as a utility, it promises steady growth.

Utilities are not a way to way to get rich, the legendary investor said in 2006 at a meeting of U.S state regulators, but they are a way to "stay rich."

Dan Eggers, a Credit Suisse analyst also likes the sector.

In a recent research note to clients he wrote, "We like the basic investment thesis for regulated utilities: 4%-5% [earnings per share] growth, 4% dividend yields, and 0.5-0.7 beta create a high single digit annual return in a low risk package." Betas of about 0.6 means utilities have 60% of the volatility of the S&P 500 Index.

Highlighted in recent Barron's piece, several of Eggers favorites are regulated utilities including: Dominion Resources Inc. (NYSE: D), Duke Energy Corp (NYSE: DUK), CMS Energy Corp. (NYSE: CMS), American Electric Power Co. Inc. (NYSE: AEP) and DTE Energy Co (NYSE: DTE).

But for broad based exposure to the sector, XLU is the way to go.

The ETF is currently changing hands around $38, yields 3.8% and holds the biggest electric utilities in the S&P 500. Its largest positions including Duke Energy Corp. (NYSE: DUK), The Southern Co. (NYSE: SO) and NextEra Energy Inc. (NYSE:NEE)

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  1. Jay | June 17, 2013

    Is this taking into consideration future dollar devaluation or without future dollar devaluation? Thanks!

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