Utilities worth considering

If you want to read the conclusion and skip all the bumph, scroll to the bottom of the post to see my updated goals for the utilities holdings in my very diversified portfolio.

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I have owned Emera since a close friend told me it was a core holding of his portfolio. He was also a big believer in Fortis, another utility. Following his trusted advice, I have owned both for years. But now I have begun to wonder are there better utilities for the retired investor.

Utilities are often called defensive stocks, but they are not immune to market volatility. Utility stocks can still experience declines in value in bear markets. If interest rates rise, investor sentiment in dividend-paying stocks may wane and the stock price may fall.

Speak of volatility and Algonquin Power and Utilites immediately comes to mind. Algonquin, once a stock market darling, is now on the outs and with good reason. Its stock is down from its highs by more than half and its dividend has taken one serious cut and another dividend reduction may well be in the cards. Not a good stock for a retiree's portfolio.

I have to confess, I bought some AQN. I didn't buy it at its peak but it did cost me considerably more than is value today and today it is flirting with becoming a six dollar stock. The dividend, 36 cents (Cdn) annually, pays me to keep it in my portfolio but the future does not look all that promising. It is certainly not a buy today.

Another stock that did not make the cut was Northland Power. It's not for me. A 311.21% payout ratio is too high, as is its Price/Earnings ration at 86.5%. Numbers like this make me very uncomfortable. I don't need the worry when there are so many other, and possibly better, choices in the utilities sector. But, I must admit that many very respected analysts recommend Northland. Its dividend is 5.54% today and its price to book is reasonable and many are very positive about its future direction.

Another stock I own is AltaGas but unlike Algonquin Power it has treated me very well. It is up almost 300% since I bought it many years ago. So, why am I not recommding ALA? Because I am looking to sell. The yield had dropped to 3.464% because to the nice run up in price. When the price dips and the yield climbs above 4% I may buy back in but not now.

So, what utilities did make the cut? Well, Capital Power looks good. With a payout ratio of less than 50%, the dividend looks solid. The Sharpe ratio for CPX indicates that from a risk-adjusted perspective CPX is better than even Emera. CPX is on my list of stocks to buy in bear market.

• Dividend: 5.19% today
• Payout ratio: 49.19%.
• Price/book ratio: 1.7X
• Price/earnings ratio: 9.9X
• Quick ratio: 0.7X

In comparison, Emera has a payout ratio of 109.50%. The fact that Emera has racked up something approaching two decades of consecutive dividend growth, keeps Emera in my portfolio but I am not adding to my position.

• Dividend: 5.67% today
• Payout ratio: 109.50%.
• Price/book ratio: 1.3X
• Price/earnings ratio: 19.2X
• Quick ratio: 0.6X

Fortis looks good from almost any angle. The payout ratio is a little high but not a worry. Fortis has paid an annual dividend for the past 49 years. Impressive. I will continue holding Fortis. If the dividend was higher I might even add to my holdings.

• Dividend: 4.15% today
• Payout ratio: 73.16%.
• Price/book ratio: 1.4X
• Price/earnings ratio: 18.6X
• Quick ratio: 0.6X

Canadian Utilities With a solid dividend run of 51 years, CU looks like another contender. Still a payout ratio of 105.40% it a little high and with a price/earnings ratio of 17.9X, I will be waiting for a correction.

• Dividend: 5.10% today
• Payout ratio: 105.40%.
• Price/book ratio: 1.8X
• Price/earnings ratio: 17.9X
• Quick ratio: 1.2X

Brookfield Renewable Partners L is my second last choice. But BEP.UN comes with a number of caveats. The payout ratio was difficult to find. Why? Because the company is not profitable making it impossible to calculate a payout ratio. Like wise the P/B and P/E are not to be found.

How did an unprofitable company make the cut? The Brookfield name. Brookfield is a name I trust. But trust only goes so far. In the past, I have lost money  following the confident predictions of analysts. I wouldn't invest more than one and a half percent in BEP.UN. I'm conservative.

How is it possible for a money-losing company to pay a dividend and a generous one at that: 5.32%? I believe Brookfield Asset Management, the parent company, manages BEP.UN's finances to ensure liquidity and operational efficiency. This management approach can involve prioritizing cash distributions over immediate profitability. Does it? I don't know, but it looks possible.

Some analysts believe Brookfield Infrastructure Partners LP, with a dividend of 4.71%, can complement BEP.UN in a portfolio. Be aware utilities are not the main focus of BIP.UN. Still, I am going to put both Brookfield companies in my portfolio.

And now to reveal my updated goals for the utilities holdings in my very diversified portfolio:

• (1.2% in AQN)
• 1.5% in BEP.UN 
• 1.5% in BIP.UN
• 3.0% in CPX
• 3.0% in CU
• 3.0% in EMA
• 3.0% in FTS

The above represents 15% of a $165,000 retirement portfolio. The above does not include AQN which is on the chopping block.

A $25,000 investment in utilities divided equally between CPX, CU, EMA, FTS and the Brookfield pair would deliver an annual income of $1,256.25 or 5.025%. (The AQN is included here but only because I am stuck with it. Maybe I should take the loss.)

Minimizing Risk -- setting limits

I'm updating my portfolio. I'm reconsidering what I own and how much. And how much is too much when it comes to stock ownership? This a core question that must be asked by all investors. Ignore it at your peril.

In an income-weighted retirement portfolio the rule of thumb is to put no more than 5% to 10% of the total portfolio value in any one stock. Following this rule lessens risk and encourages diversification.

Risk Management: As an investment in any one stock grows, one's exposure to company-specific risks grows. Think of Nortel. If you don't understand, Google Nortel or click the link.

Diversification: A well-diversified portfolio holds a variety of stocks spread over a good mix of sectors and asset classes. For instance, if it has been determined that the investment goal is to have 12% of the portfolio value invested in the telecom sector, this investment would encompass a number of telecoms and not just one. 

An equal weighting of 3% each of BCE, Cogeco, Quebecor and Telus would result in a 12% total investment in telecoms. Of course, equal weighting is not demanded. Personally, I would underweight BCE and overweight Telus and favour Quebecor slightly over Cogeco with the remaining funds.

Income Generation: Always be aware of the income potential of any investment. But a warning, do not let the need for income overly influence your investment decisions. A very large dividend can be a warning and not a carrot. Don't take the bait. 

BCE is yielding 8.5% today. That is a warning. I suggest underweighting BCE in your portfolio and overweighting your investment in better positioned telecoms is the right approach. I have done much better with Cogeco and Quebecor than I have with BCE. The jury is still out when it comes to Telus.

Portfolio Adjustments: As a retiree grows older, the usual recommendation is to reduce the exposure to equities and increase the fixed-income investments. This can be tougher than it sounds. Move funds from equities into bond ETFs and money can still be lost. Put the funds in GICs and if inflation outpaces the interest paid, one suffers a loss in buying power. Losing, like winning, is simply part of life. Just try to win more than you lose.

I swim against the tide here. I like to have massive dividend income generated by trusted companies. When expenses are as expected, there is money left to reinvest in the market. When unexpected costs arise, the flow of cash is used to meet or at least reduce the unexpected cost. So far, this approach has worked well for me. I usually have no more than 2% of my funds in cash but I am flexible.

Conclusion: I cannot state this too strongly. Never allocate more than 10% to any one stock. This is the one rule that I have that is carved in stone. Some analysts will advise putting more into a stock and they will call this an aggressive income strategy. Don't do it! Think Nortel.

By the way, the art shows a small piece of my actual retirement portfolio spreadsheet.