I don’t get to do this often. I normally write for Energy and Capital’s sister publication, Wealth Daily. But when your fearless leader and my good friend — Keith Paul Kohl — asked me to share my wisdom with his readers, I said, “Who… me?”
I kid, I kid. The fact is, I jumped at the chance. I may not have any particular wisdom that Keith and his crew do not. That’s a pretty savvy bunch you’ve got here at Energy and Capital. In fact, I hit Keith up all the time for his detailed knowledge of the oil patch. I’ve never met anyone who could rattle off production and demand stats like Keith can. No doubt you’ve gotten plenty of fantastic insight from Keith…
Of course, it’s a quid pro quo arrangement. I get my oil fix from Keith, and he hits me up for dividend and income advice, because as editor of The Wealth Advisory newsletter, that’s my area of expertise.
Today, however, I’m going to do something a little different. Instead of offering you an idea about a dividend stock or two that you should own, I’m going to tell you about a group of dividends that you should avoid like the plague. So let me ask you: do you know what the best-performing dividend stocks have been over the last few years?
If you said data center REITs, that’s a good guess. I’ve got two data center REITs in the Wealth Advisory portfolio, and they are up 142% and 74%, and pay 2.5% and 8% a year in dividends, respectively. That 8% is fantastic, and that stock is going a lot higher.
But the data centers are just one part of the REIT sector, so unfortunately, that doesn’t count.
The best-performing dividend stocks out there are the utilities. Yep, boring old utilities have been on fire for two years running as investors are desperate for yield, thanks to the Fed’s inane monetary policy. So they’ve piled into what seems to be a solid, safe sector that pays better than 30-year T-bills.
But here’s the thing. Utilities are not safe at all. They are fighting a war on two fronts: interest rates and distributed power. And it’s not going to end well…
Widows and Orphans
Utilities are often called “widow and orphan” stocks because they are deemed so safe. In fact, the very first mutual funds were created in Scotland as a way for the government to generate income to pay benefits to society’s most helpless. The thinking was that the government could buy shares of stable dividend companies and thus not have assistance to widows and orphans be a drag on the state.
That’s where the investment phrase “widows and orphans” comes from. But we’re going to have to change meaning of that phrase to exclude utilities. Here are a few tidbits to whet your appetite…
- Electricity demand from the grid peaked in 2007. It hasn’t come back to those levels.
- Wynn Resorts and MGM just agreed to pay ~$150 million to break their power contract with Nevada Power. They think they can save more than that by creating their own power.
- Right now, Apple is filing to sell electricity direct to consumers, because it has a huge surplus.
- One of America’s biggest utilities has had falling revenue for three years running. If that keeps up, a dividend cut is coming.
Utilities are losing out to distributed power. Distributed power is where people and companies generate their own power with solar panels or wind turbines or whatever.
Bloomberg recently put out an article about the impending death of the utilities industry and basically reiterated everything I’ve been telling you.
That move by MGM Resorts and Wynn Resorts took about 5% of NV’s revenues right off the top line. And the casinos aren’t the only big companies giving utilities a hard time. Google already has a license to trade power, and as I said, Apple’s getting into the electricity game, too. That’s huge considering Apple’s fields stretch from CA to NC.
The analysts at Bloomberg are finally catching onto what we’ve seen coming for a while now. Utility companies can’t compete now that solar is becoming a viable source for energy generation and both corporations and retail customers are cutting them out of the picture.
Falling costs for distributed energy such as solar panels and smarter approaches to energy efficiency — along with a desire by some commercial customers to break away from utilities — mean [the] pressures [on utilities] aren’t going away.
Here’s a little math that Bloomberg threw together to really illustrate how bad the effect is going to be on the utility stocks:
At a crude level, imagine a utility with a cost of capital of 8 percent, paying a $1 dividend expected to grow by 4 percent, year in and year out. Now raise the cost of capital by 2 percentage points and cut the expected growth rate by the same amount. Hey, presto! That stock just halved.
The most important part is that last sentence. A 50% loss! And that’s with a small increase in costs. Imagine a 4% or 6% increase. The losses to utility stocks would be even bigger!
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The German Example
We have a model for what inevitably happens as more American people and companies turn to renewable power. It’s from Germany. A recent Bloomberg article said this:
Chancellor Angela Merkel’s unprecedented shift to renewable energy squeezed margins at traditional coal and gas plants in Europe’s biggest power market.
Germany’s biggest utility, RWE, is feeling the squeeze. Check out this two-year chart:
From $40 to $12 in two years. That’s bad, and I think something similar is in store for U.S. utilities. Sure, RWE has rallied 35% from those lows, back to $16, but that’s cold comfort for its shareholders. Those poor widows and orphans may end up back on the street. Don’t let that happen to you…
Check your investments, your mutual funds, or your index funds. Make sure you don’t own utility stocks. I can’t tell you exactly when the selling will start, but they are basically at all-time highs right now.
Until next time,
Until next time,
Briton Ryle
@BritonRyle on Twitter
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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.
