Thursday, 21 June 2012

Investor's Checklist: Utilities

Utilities are no longer the safe havens they once were.  Treat them with an appropriate amount of caution.

The competitive structure utilities must operate under is largely set at the state level.  Some states have gone far along the deregulation path; others have utilities that are fully regulated.  Keeping track of changing regulations in different states can be maddening, but it is necessary to understand the sector.

Regulated utilities tend to have wide economic moats because they operate as monopolies, but it is important to keep in mind regulation does not allow these firms to parlay this advantage into excess returns.  In addition, regulation can (and often does) change.

Another risk all utilities face - deregulated or not - is environmental risk.  Most power plants generate pollution of some kind.  Should environmental regulation tighten, costs could go up.

Utilities have a great deal of leverage, both operational and financial.  This is not so important for regulated firms, but it exponentially raises risk for companies facing increasing competition.

If you buy a utility for its dividend, make sure the firm has the financial wherewithal to keep paying it.

Utilities that operate in stable regulatory environments with relatively strong balance sheets while staying focused on their core businesses are the best bets in the sector.  

Ref:  The Five Rules for Successful Stock Investing by Pat Dorsey

No comments: