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Retirement portfolios should provide those in their golden years with a stable stream of income that lasts their entire expected lifespan. Therefore, it is essential to ensure a safe and perpetual withdrawal rate. To do this, retirees should choose high-quality, low-volatility stocks that have good potential for dividend growth.
The TSX utilities sector is perfect for this. This sector is characterized by large capitalization companies with decades of operation, profitable management and steadily increasing dividend payouts. Moreover, the utilities sector is very defensive and able to remain profitable even in a recession.
Why do we want public service shares?
Canadian utilities stocks are an excellent defensive play thanks to the following characteristics:
- A steady streak of more than 15 years of dividend payouts and increases (“Dividend Aristocrats”).
- High current dividend yields of 3% or more, but with a sustainable payout ratio ranging from 35% to 65%.
- A weak beta. A beta greater than one suggests the stock is more volatile than the market as a whole, while a beta less than one indicates a stock with lower volatility. A negative beta less than zero indicates an inverse relationship.
Utility stocks typically exhibit all three of these characteristics. Having them at the core of your portfolio can provide stable income while minimizing volatility. When the market fluctuates wildly, your portfolio will be much more stable and the dividends will allow you to earn income without selling too many stocks.
Which utility stocks should you buy?
If we apply the above criteria, these following three TSX utility stocks seem to be our best options:
- Fortis (TSX:FTS)(NYSE:FTS): Dividend yield of 3.50%. Beta of 0.10
- Emera (TSX:EMA): Dividend yield of 4.38%. Beta of 0.26
- Canadian public services (TSX:CU): Dividend yield of 4.75%. Beta of 0.56
None of these stocks are shockproof (market risk will always exist), but thanks to their low betas, they tend to follow the market less in times of turbulence.
In addition, their dividend yields are very attractive and they all show a series of payout increases over several decades. Buying during a recession to secure a low return on cost can significantly increase your earnings.
What are the risks ?
There is no free lunch in investing. Each strategy, stock or portfolio will have its own unique risk profile, and these three stocks are no different. Before investing, be sure to consider these risks and make an informed decision about the weighting of utility stocks in your portfolio.
- Market risk: Despite their low beta, these stocks could still crash during a bear market, as investors panic and sell risky stocks and turn to bonds, even if they have excellent fundamentals. Although they may recover, their share price could remain depressed for some time.
- Dividend distribution risk: There is no guarantee that management will continue to pay a dividend, increase dividends or maintain current payout ratios, even if historically they have done so.
- Interest rate risk: Utilities stocks could be negatively affected by rising interest rates as their debt becomes harder to repay.
- Regulatory risk: Utilities that operate in an oligopoly run the risk of being constrained by anti-competitive legislation or policy that could limit their profits or operations.
- Concentration risk: Investing the bulk of your portfolio in a single sector can open you up to an unforeseen industry-specific event that drastically changes, disrupts or destroys the companies in which you invest.