There’s certainly something very attractive about a utility stock that pays a 4.6% dividend yield when the 10-year U.S. Treasury is paying just 2.8%. But investors in American Electric Power (AEP) need to realize that if the U.S. economy is speeding up rather than slowing down, they’re bucking investor sentiment by holding utility shares.
Utilities are great income investments when investors are worried about economic growth and are looking for safety. The prices of utility shares, however, tend to fall when investors think the economy is picking up and they start to be willing to take on a little more risk in order to earn, they hope, a lot more reward. At that point in the cycle, utility stocks aren’t attractive on a total return basis.
Utility revenues themselves go up when the economy grows at a faster rate because more economic activity means higher consumption of electricity. But not enough to outweigh the shift in sentiment away from safety and toward risk.
And shares of American Electric Power have another problem. Because the company has been able to cut costs and to successfully negotiate rate increases in many of its markets, the utility has done better than many of its peers in the weak economy. That means the shares have appreciated in price more than those of many other utilities and that has lowered the stock’s yield in comparison to its peers. Although a 4.6% dividend yield sounds hefty, the average utility yields 4.9% right now, according to Standard & Poor’s.
I think the shares have a limited upside—S&P has a 12-month price target of just $39 for a stock now trading at $36 a share—if sentiment doesn’t turn too strongly toward more risk and away from safety. If the economy does strengthen enough so that investors feel a little better about economic growth, I think the shares could actually fall in price.
I just don’t see this stock attractive at this point in the economic cycle on a total return basis
sstanelle — you were right! and I was right, because I hung on to AEP and enjoyed a nice steady dividend. Jim is a writer/investor who has a very optimistic view of things. Unfortunately he’s been much too optimistic about the world economy over the past few years which has led him to jettison some great dividend picks like this and embrace some riskier equities.
I don’t see the economy picking up for maybe a couple years, if we’re lucky. I would like to know why Jim thinks that the economy will pick up.
There is no recovery. The VP said that we misunderstood, he meant Recovery Act summer. not recovery summer.
Someone mentioned the “rush to get out bond” here. I can just imagine how that will look like!
The economy is not going to pick up. Most of the growth this past year was related to inventory. That stimulus is gone. Employment is still basically getting worse as jobs are out-sourced. (All the big tech companies like MSFT, DELL, HP, APPL etc. have 10 times as many workers in China as they do here. Those are lost American jobs. Residential real estate has millions of homes that will be foreclosed on. States and Municipalities are going broke and will need to lay off employees. Consumer spending will be depressed by all of these. There are many more problems. There is no driver for jobs, so no improvement in consumer spending.
No Recovery.
I agree. This market is a crap shoot. If there is an upside its small or a bubble. That is where the risk is. Jim, i think defensive stocks are good now and 4.6% looks REAL good. So does gold. Recall when you recommended Whirlpool. Its dropped 25% since then. That was just a month or so ago. And those biggies could drop like rocks once the economic indicators turn more sour. In fact, i think CASH looks good! lol
I think this is a good stock to keep to have some protection against a worse than expected recession (at a good yield), same rationale than the one used for bonds. I don’t think the stock will go down on strong growth, it would actually float higher, maybe less than others, but on both scenarios it looks good enough.
I’m just as nervous about my bond holdings as my stock holdings. I don’t have a warm and fuzzy feeling about a recovery in the US. It’s stodgy stocks like MO, JNJ, PG etc. that I feel the most comfortable with. I got rid of my utility stocks some time ago, but am thinking of picking up stocks like ED again in an attempt to be ahead of the rush to leave bonds.
“The prices of utility shares, however, tend to fall when investors think the economy is picking up and they start to be willing to take on a little more risk in order to earn, they hope, a lot more reward.”
Who in their right mind thinks ‘the economy is picking up’?? We still have horrific dynamics in employment, commercial real estate, personal balance sheets, gov’t budgets, tax policy….need I continue?