Dividend Seekers: Utility Stocks are Pricey Now – Here’s the Path to Shares With Dividend Growth

Everything you need to know about investor sentiment right now can be found in the utility sector. This staid corner of the market has always been the go-to sector for yield seekers. Now more than ever: The likes of Consolidated Edison (ED), Southern Co. (SO), PG&E (PCG) and Dominion Resources (D) all serve up dividend yields that are more than double the 1.5% yield for a 10-year Treasury note.

PCG Dividend Yield Chart

PCG Dividend Yield data by YCharts

What yield seekers might not realize though is that legions of risk averse investors spooked by market volatility and starved for yield have bid up utility stocks to pricey levels.

Historically, the utility sector has an average price/earnings ratio about 25% below the overall market. Today the sector trades at a large premium to the market. According to S&P IQ, the utility sector within the S&P 500 stock index has a PE ratio of 15.6 based on estimated 2012 earnings. The overall PE ratio for the S&P 500 index is 13.1. And with a forecast of sluggish earnings growth in 2013 for the sector, that high valuation is expected to persist next year as well. S&P IQ forecasts a 15.1 2013 PE ratio for the utility sector, compared to 11.7 for the overall S&P 500.

Just take a look at the PE ratio for a few companies among the top 10 holdings in the Utilities Select Sector SPDR (XLU): Southern Company, Dominion Resources, and PG&E:

SO PE Ratio Chart

SO PE Ratio data by YCharts

That seems like a pretty steep price to be paying for yield. Sure, as long as investor sentiment remains wary-to-scared, this “defensive” sector will remain in demand. But those high valuations could spell trouble once sentiment shifts.

Another factor that needs vetting when fishing for yield in utilities is the dividend payout ratio. The utility sector has always had a much higher payout ratio than the broad market; that’s just a function of it being a lower-growth industry that churns out steady dividends. The average payout ratio over the past 10 years has been around 60% according to FactSet, compared to less than 30% for the S&P 500.

That said, before you chase after a high yield, it pays to check the dividend payout ratio.

For example, Pepco’s (POM) 5.5% yield looks mighty fine, but a payout ratio above 90%, well, not so much.

SO PE Ratio Chart

SO PE Ratio data by YCharts

Compare that to PPL Corp (PPL).

PPL Dividend Yield Chart

PPL Dividend Yield data by YCharts

If you’re looking for a Treasury beating yield, selling at a below average price-earnings ratio and a payout ratio that gives the company room to grow the dividend (hopefully at an inflation-beating pace) you might want to expand beyond the utility sector.

You can use the YCharts Stock Screener to find your own high-paying stocks, and then analyze each issue further with YCharts’ other metrics by clicking on the stock symbols in this article.

Take a look at Chevron (CVX). A 3% yield from a company that has consistently increased its dividend, yet still has a low payout ratio. Meanwhile, the current PE ratio is about half the average PE ratio for the utility sector.

CVX Dividend Yield Chart

CVX Dividend Yield data by YCharts

Not grooving on energy? Okay, how about a techie. Here’s Applied Materials (AMAT).

AMAT Dividend Yield Chart

AMAT Dividend Yield data by YCharts

Or a stable insurer per chance? Here’s AFLAC (AFL).

AFL Dividend Yield Chart

AFL Dividend Yield data by YCharts

You get the idea. There are ways to get yield today from companies with steady earnings, without having to pay up for a pricey utility.

Carla Fried is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.



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