Turning the Lights Up on Utilities

June 11, 2014 3:57 PM
By Glenn McIsaac

If you want to know what has powered the S&P 500, check out utilities, one of the top three performing sectors since 2004, with an average annual return of 10.4%. 

In their search for total return, many investors have fallen in love with utilities stocks. And who could blame them? Over the past decade, the utilities sector has been one of the top performing components of the Standard & Poor's 500 (See Chart 1) due to solid earnings growth (an average compound annual growth rate of 4%) and declining interest rates.


Chart 1. Over the Last 20 Years, Utilities’ Cumulative Return Has Outperformed Both the S&P 500 and 10-Year Treasuries By a Significant Margin

Source: Zephyr (returns) and Bloomberg (dividend yield and Treasury yield).
The S&P 500® Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries.
The S&P 500® Utilities Index comprises those companies included in the S&P 500 that are classified as members of the GICS® utilities sector.
The historical data are for illustrative purposes only, do not represent the performance of any Lord Abbett mutual fund or any particular investment, and are not intended to predict or depict future results. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Due to market volatility, the market may not perform in a similar manner in the future.
Performance data quoted represents past performance. Past performance is no guarantee of future results. 


Earnings growth has been driven by robust investment opportunities (mainly for distribution system reliability, new transmission and environmental upgrades) and generally constructive regulation which has enabled utilities to get the rate adjustments needed to earn a fair return on those investments.

Utilities have relatively high dividend payout ratios and are often viewed as income stocks. The drop in interest rates (10-year U.S. Treasury yields down 180 basis points since 12/31/2003) has made utility dividend yields more attractive and driven up utility stock prices (and total returns).

Utility earnings growth appears likely to continue, but utility stock performance could face headwinds if interest rates move higher. 

Do you think utilities will run out of gas? Join the conversation here. 

Lord Abbett Research Analyst Glenn McIsaac covers the utilities sector.

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I've been wondering about just that issue. How will the President's stated direction of coal generated power affect the remaining utilities, their grid system and the delivery of power? I know that in the early 90's he discussed that if he could shut the coal plants down that it would naturally raise the power cost by 30%. What happens to the utilities (and economy) when the cost of power is so high as a result of this and necessary improvements in infrastructure that people can't afford to heat their homes? Certainly we have many receiving assistance now within our various geographic locations.
Forcing the premature shutdown of coal-fired power plants, and effectively blocking construction of any new coal plants, will likely increase the cost of electricity, diminish grid reliability, and limit the flexibility of utilities to respond to any volatility in natural gas prices in the future. Utility earnings and stock performance are unlikely to be directly impacted, but utilities will likely have to pass along the increased costs by charging higher electric rates to customers. It will take a number of years for the effect of these policies to be fully apparent, but over the longer-term the additional burden on consumers will likely have a negative impact on economic growth and employment.