This market has been something of a head-scratcher this year. Despite persistent calls from economists for a recession that has yet to arrive, the economy remains resilient.
The best-performing stocks have been glamour names that tend to outperform during periods of low rates and investor enthusiasm. We have neither.
But while it’s strange behavior for the stock market historically, it fits right in with the market action of the last several years.
The market crashed over 30% when the pandemic and lockdowns hit. But then stocks mounted an amazing recovery that began shortly after the lockdowns began, even though they would continue for more than a year.
Stocks fell into another bear market last year, and the Fed raised the Fed Funds rate at the steepest pace in decades to fight off 40-year-high inflation.
At the beginning of this year, the vast majority of pundits had forecasted more of the same in the first half of 2023. But instead, the S&P 500 rallied 19.5% in the first seven months of the year into a new bull market.
Last year, the worst-performing market sector by far was technology. This year it is by far the best-performing sector. Last year, energy was the best-performing sector. In the first half of this year, it was the worst-performing. But that previously beleaguered sector has made a strong comeback since, as oil prices are on the rise.
Other sectors like consumer discretionary stocks that had been among the worst sectors last year are among the best this year. Defensive sectors, including healthcare and utilities, that delivered stellar returns last year have been dogs this year. In fact, the utility sector has displaced energy as this year’s worst-performing S&P 500 sector.
This year’s market rally has stalled as stocks have pulled back in the late summer and early fall. But a pullback is normal and even healthy after the S&P mounted a better than 30% rally from the low. Most pundits are now optimistic about the rest of this year as inflation has fallen fast, the Fed is about done hiking, and there is no recession in sight. Maybe the pundits are right. But as the past several years illustrate, you never know.
The last few years have also illustrated a tendency for downtrodden stock sectors to rise from the canvas and become among the market’s best performers. Many utility stocks are currently near multi-year lows. But not because of the operational performance of the companies, which has largely remained solid. It’s mostly because of high interest rates, that may be peaking, and the mood of investors so far this year, which always changes.
Utilities are dirt cheap in an expensive market. They are also stellar relative performers in a slowing economy. But they are likely to rise from the current dark depths even if the economy remains buoyant. Sure, the stocks could continue to flounder for longer. But it’s a great bet that things continue to be unpredictable and these stocks are a lot higher in six months or a year.
There are two utility stocks that are particularly attractive right now. They are not just stodgy and boring stocks that may have the benefit of good timing. Both of these stocks have a long history of not only blowing away the returns of the utility index but dwarfing overall market returns as well.
2 Dirt-Cheap Utility Stocks
NextEra Energy, Inc. (NEE)
NextEra Energy provides all the advantages of a defensive utility plus exposure to the fast-growing and highly sought-after alternative energy market. It’s the world’s largest utility. It’s a monster with about $21 billion in annual revenue and a $136 billion market capitalization.
Ordinarily, when you think of a huge utility you probably think it has lackluster growth and a stable dividend. But that’s not true in this case. Earnings growth and stock returns have well exceeded what is normally expected of a utility.
For the last fifteen- ten-, and five-year periods, NEE has not only vastly outperformed the Utility Index but has also beaten the returns of the overall market, even after falling over 19% so far this year.
How can that be? It’s because it isn’t a regular utility. NEE is two companies in one. It owns Florida Power and Light Company, which is one of the very best regulated utilities in the country, accounting for about 55% of revenues. It also owns NextEra Energy Resources, the world’s largest generator of renewable energy from wind and solar and a world leader in battery storage. It accounts for about 45% of earnings and provides a higher level of growth.
Investors love it because they get the safety and income of a utility and still get great growth and capital appreciation. It’s the best of both worlds. There is also a huge runway for growth projects. NextEra has deployed $50 to $55 billion in the last few years on growth expansions and acquisitions. It also has a large project backlog.
Since 2006, NextEra grew earnings by an average annual rate of 8.4% and grew the dividend at an average rate of 9.8% per year. That propelled the market returns stated above. The company is targeting 10% earnings growth from 2021-2025 and 10% annual dividend growth through at least 2024. NextEra has a long track record of meeting or exceeding goals.
NEE has restarted an uptrend after a drubbing that crashed the stock to near the 52-week low for reasons that are likely to prove very temporary. Everything that propelled the stock higher in the past is still firmly in place. In fact, things might be better in the future than they were in the past.
This historically stellar stock is currently sitting not only at the 52-week low, but the lowest point since 2020. Yet earnings and operational performance have been solid. It’s all about temporarily high interest rates and the current market mood. And those things are likely to change.
Xcel Energy (XEL)
Xcel Energy provides all the defensive and recession-resistant advantages of most utilities plus exposure to the fast-growing and highly sought-after alternative energy market. It has the reliability of a utility plus much more growth than average from its sizable clean energy business.
Xcel is a regulated electric and natural gas utility serving 3.7 million electric customers and 2.1 million natural gas customers in eight states, primarily in the northern and southwestern U.S. It is also one of the largest renewable energy providers in the U.S. with about 30% of electricity sales generated from alternative energy sources.
Alternative energy is what separates XEL from the utility pack and makes it a much better investment. It enables investors to play defense and offense at the same time. You get stable earnings and low volatility along with exposure to one of the most exciting and fast-growing areas of the market.
Here are some other things to like about the stock:
- Long-term EPS growth 5% - 7%
- Annual dividend growth 5% - 7%
- Dividend payout ratio 60% - 70%
- Credit ratings in the A range.
Results support the fact that Xcel is an excellent utility stock. XEL produced average annual returns of about 12% for the last ten years. That’s far better than its peer group over the same time. But that number is after the stock had a steep plunge recently.
While the longer-term trajectory looks excellent, it’s really the recent market action that prompts the recommendation. The stock has gotten very cheap because of near-term circumstances and market gyrations that are unlikely to last.