The Ten Largest US Electric Utilities By Market Value

The Utility Sector is traditionally preferred for steady income and growth. The sector has lagged so far this year due to many factors including the potential impact due to higher interest rates. Currently the Dow Utility index has a P/E ratio of 16.32 compared to over 22 a year ago. The dividend yield for the index is 3.69% relative to the 2% for the S&P 500.

The decline in utility stock prices year-to-date presents an opportunity for investors willing to wait out the short-term volatility and focus on the long-term. Among the utility industry electric utilities offer many options. One way to identify electric utilities for potential investment is to research and go with the largest companies.

The ten largest US electric utilities based on market value are listed below with their current dividend yields for consideration:

1.Company: Duke Energy Corporation (DUK)
Current Dividend Yield: 4.44%

2.Company: NextEra Energy Inc (NEE)
Current Dividend Yield: 3.01%

3.Company: Dominion Resources, Inc. (D)
Current Dividend Yield: 3.78%

4.Company: Southern Company (SO)
Current Dividend Yield: 5.06%

5.Company: Exelon Corporation (EXC)
Current Dividend Yield: 4.01%

6.Company: American Electric Power Co. (AEP)
Current Dividend Yield: 3.88%

7.Company: PG&E Corporation (PCG)
Current Dividend Yield: 3.61%

8.Company: PPL Corporation (PPL)
Current Dividend Yield: 4.85%

9.Company: Public Service Enterprise Group Inc. (PEG)
Current Dividend Yield: 3.92%

10.Company: Edison International (EIX)
Current Dividend Yield: 2.90%

Source: Statista

Note: Dividend yields noted above are as of July 24, 2015. Data is known to be accurate from sources used.Please use your own due diligence before making any investment decisions.

Disclosure: Long NEE

Too Much Financial Activity And Its Consequences

Financial activity by banks and other financial institutions have increased exponentially in the past few decades according to a report by OECD. The authors of the report note that while increased credit is good for growth in the short-term it actually leads to slower growth in the long-term.

From an article previewing the report:

Over the past half-century credit by banks and other financial institutions to households and businesses in OECD countries has grown three times as fast as economic activity. Stock market capitalisation has tripled relative to GDP over the past 40 years, but today the value of stock markets still only equals 65% of GDP, just over half that of financial sector credit.

The OECD economists looked at how this growth in the financial sector affects growth in the rest of the economy. Initially, an expanding financial sector is beneficial, but it eventually reaches its ideal weight, and apart from contributing to inequality, “further increases in its size usually slow long-term growth”. This conclusion holds even when you consider a range of other factors including country specificities, the business cycle, and even financial crises. In general, more credit to the private sector slows growth in most OECD countries, while more stock market financing boosts growth. Bank loans slow economic growth more than bonds. Credit is a stronger drag on growth when it goes to households rather than businesses.

Source:  Too much money is bad for you, June 2015,  OECD

The following graphs show the tremendous growth in financial activity in OECD countries:

Click to enlarge

Too Much Financial Activity-OECD Chart

Source: Finance and Inclusive Growth by Boris Cournède, Oliver Denk and Peter Hoeller, June 2015, OECD

From the above research paper:

The analysis will therefore also use two direct measures of financial activity: the volume of credit provided by financial intermediaries to the non-financial private sector and stock market capitalisation.2 The volume of credit provided by banks and other financial institutions to non-financial firms and households, henceforth referred to as “intermediated credit”, measures a key output that financial intermediaries generate for the real economy. Stock market capitalisation also provides a gauge of the important service that the financial sector provides by facilitating the equity funding of businesses. Similarly to the value added of finance, intermediated credit and stock market capitalisation have both been on upward trends:

• Credit by banks and other intermediaries has risen strongly in nearly all OECD countries since the 1960s, on average more than tripling relative to GDP (Figure 1, Panel B). Several financial crises during the 1990s interrupted the upward trend in the Nordic countries, Mexico and some Asian countries, though in most cases only briefly. Credit-to-GDP ratios have also come down since the onset of the global financial crisis as lending activity has shrunk and write-downs have been taken on past loans (Bouis et al., 2013). In many OECD countries, the growth in credit
intermediation has outpaced the growth in financial sector value added. This difference relates to lower net interest margins, which may reflect possible increases in productivity as well as likely reductions in screening efforts and credit quality (Keys et al., 2010).

• The amount of stock market financing has expanded considerably in OECD countries over the past four decades (Figure 1, Panel C). The expansion has been accompanied by very large bubbles in Japan in the late 1980s and globally in the late 1990s.

The key fascinating takeaway from this report is that high stock market financing and unrestrained credit availability is not a sound policy for economic growth.

Are Foreign Stocks Unnecessary For US Investors?

U.S. investors have generally low allocation to foreign equities for a variety of reasons. For example, it may be due to their advisors recommending that they hold most of their assets in U.S. stocks. Others may feel comfortable investing in firms that they know about and can even buy the firms’ products in the local grocery store. This can also be called as ‘home bias” by which investors prefer their home over some unknown company in far away land. Some others may invest mainly in U.S. stocks due to patriotism or in the mistaken belief all the best things in the world today exist only in the US.

I recently came across an article on international diversification that made some interesting arguments on the need for foreign stocks. From the article:

On average, 44% of the revenues of these 50 companies are derived from outside the U.S. Even if surprising, this is actually a conservative figure inasmuch as some companies only list “North American” revenues, which would include Mexico and Canada, as opposed to U.S. revenues. Other companies, like AT&T, do not state their foreign revenues, so AT&T is counted in the exercise as zero, despite having significant non-U.S. activities. One piece of information AT&T does provide is that it has $26 billion of foreign currency swaps (notional value) on its balance sheet, which may be compared with $129 billion of total revenues – presumably, its non-U.S. revenue is not trivial.

The largest 100 companies in the S&P 500 Index, 20% of the list by number, comprise 61% of the market value; their average proportion of foreign revenues is 39%. There is a different way to calculate this: not on a simple average basis for each company, but weighted by each company’s market value; in this instance the average value weighted foreign revenue contribution is 26%. If weighted, instead, by asset value, the figure might well be higher.

But those fine points don’t matter, do they? We now know that investors, whether major institutions that, effectively, advise themselves, as well as individuals who are advised by institutions, are being told to allocate roughly 30% to 40% of their stock investments, which might otherwise be in the S&P 500 or essentially similar indexes, to non-U.S. companies. Yet, by holding the S&P 500 those investors are already fully allocated internationally. Say what???

One of the paradoxes here is that the major U.S. companies are quite globally diversified in terms of sources of business, if anyone would care to read their annual or quarterly reports. Historians will one day be baffled as to how well-educated people were convinced to invest billions, and perhaps hundreds of billions of dollars, in companies of which they know nothing, often located in places they would be afraid to visit, all in search of diversification that was already achieved by the American firms that were being sold to fund the international diversification effort in the first place.(emphasis mine)

Source: Under the Hood: What’sin Your Index? (An Ongoing Series), Horizontal Kinetics

The above argument is wrong on many levels. There are many reasons for US investors to invest in foreign companies. In fact, it would be foolish to not invest in foreign equities. Here are a few reasons investing in foreign companies makes sense for US investors :

  • While many US firms are global multi-nationals and generate a substantial portion of their earnings from outside the US, they still cannot compete effectively with domestic firms of individual countries.For example, Google is not the top search engine in Russia as Russians prefer their own home-grown search engine called Yandex(YNDX). Similarly China has hundreds of domestic firms which are leaders in their respective fields. Companies such as Xiaomi, Alibaba(BABA) are some examples. Hence in order to profit from the growth of these companies it is necessary to invest in them. I wrote an article on this topic last year which can be found here.
  • Though US firms generate billions in profits from overseas it does not mean they share the earnings with investors. US firms are notorious for having low payout ratios and many prefer to buy back their own shares rather than pay it to shareholders in the form of cold hard cash. Hence an income investor can earn higher income from investing in foreign firms than US firms.
  • Most well-respected foreign firms have plenty of information on their business and financial activities online usually in English too. Hence the idea that well-educated investors are in the dark by investing in these firms is ridiculous to say the least.
  • Companies that are equal to or even better than US firms exist in other developed countries. For example, banks in Scandinavian countries such as Norway and Sweden and banks in Canada are equal to if not better than in some aspects than their American peers.
  • In summary, US investors should not limit themselves to American multinationals in order to achieve international diversification. In order to benefit from growth in emerging, frontier and other developed markets, investing in the domestic firms of these markets is a wise strategy for investors.

Disclosure: No Positions