Over the past twenty-five years, the Board of Directors of an electric utility company with operations in Georgia, Alabama, Florida, and Mississippi called “Southern Company” have grown the dividend payments to shareholders by a compounded annual growth rate of 4.89%. This has been a fairly static figure. The ten-year dividend growth at Southern is 4%, the fifteen-year dividend growth is 4.3%, and the twenty-year dividend growth is 4.7%. The earnings usually grow about a percentage point higher, with the twenty-five year dividend growth at Southern being just shy of 6%.
Like most utilities, the firm is leveraged to the gills with $27 billion in debt and $10.4 billion of the debt due within five years. Southern makes $2.6 billion per year in profits, and is expected to make a total of $13 billion in profits over the next five years.
This is a pretty standard experience of being a utility stock shareholder. The growth is steady, but never the kind of thing that make you sit up higher in your chair and take notice. Small utility players get bought out and added to the fold to increase earnings. Expensive capital projects are undertaken, and the firm usually asks for a 10-12% rate hike before eventually securing from the commission an annual rate hike somewhere in the 4% to 8% range (Southern utility commissioners have been receptive to higher rate increases over the few years).
The sector never really seems like an especially attractive proposition because the investment comes with a “lid” attached to it. You’re never going to get the kind of long-term returns with a utility that you get from a stock like Nike or Visa because the rates are tightly regulated, the market share of utility customers is darn near 100% in an area, the capital expenditures are pricey, and there is long-term debt on the balance sheet as far as the eye can see. There’s nothing especially enticing about any of these elements.
And yet, what would you guess is the twenty-five year compounding rate for Southern Company, which has grown dividend by 4.89% and earnings at 5.95% annually since 1990? Assume full dividend reinvestment. The answer is 13.4%. The long-term returns for utility stocks is non-intuitive because there are so many factors militating in favor of low growth.
But what it lacks in growth, it makes up in stability. The predictability of the cash flows is darn near guaranteed. The electric utility bill is something that gets paid regardless of general market conditions. Even people who aren’t especially wise with their salaries pay their utility bills before thinking about “disposable income” available.
Recessions like 2008-2009 proved to be a blessing in hindsight for those that owned Southern Company and elected to reinvest during those two years. Every 100 shares owned at the start of 2008 turned into 112.4 shares of SO eight dividend payments later at the close of 2009. There were three dividend freezes in the past twenty-five years, but no dividend cuts, and the starting dividend yield is usually somewhere in close proximity to the 5% range. Collecting $5 on $100, and then watching that $5 stream naturally grow by 4.89% per year, and then get plowed back into additional shares proves to be a potent mix that creates investment returns that far exceeds the superficial kind of expectations you might have when you look at the growth rates and general operating characteristics of these types of firms.
The twenty-five year returns for Southern Company are exceptional in their own right, but are downright extraordinary when measured against the mediocre growth rates that propelled them. If you invested $10,000 in Southern Company back in 1990, you could have been collecting $480 in your first year as a shareholder in the corporation. Nothing exceptional–just a stodgy income source. Fast forward to today, and you would have 5,752 shares with a net worth of almost $279,000.
The quarterly dividend is at $0.5425, giving you $3,120 every quarter. Your annual income would be $12,480. Adjusted for inflation, a $10,000 investment back in 1990 was about $23,800 today. In inflation-adjusted dollars, you’d be collecting 52.43% in dividends today. In nominal dollars, you’d be collecting 124% of your investment in dividends from Southern today.
What should you do with this information today? Keep in mind this–of the $279,000 in Southern Shares today, approximately 68% of the $269,000 in total gains can be attributed to either dividend payments or dividend reinvestment. If you assume a constant 28% dividend tax over that time frame, your gains would be knocked down to $193,680. Or, a $203,680 net worth counting your initial $10,000 investment. That takes a percentage point off your total compounding.
Even if you were in a high tax bracket and owned this stock in a taxable brokerage account, things still worked out. Your after-tax returns with Southern Company still beat the pre-tax returns of the S&P 500. But it’s true that Southern Company returns 70% of profits as dividends. The reinvestment of dividends plays a disproportionate role in driving long-term returns for Southern Company compared to the typical S&P 500 member firm. For that reason, a priority should be placed on tucking this baby into a tax-deferred account of some kind.
The perceptions of the utility industry are quite different from what actually happens. The share price hardly goes anywhere–heck, Southern Company traded at a high of $34 in 2004 and trades at $48 now. It just doesn’t seem like there is any movement. The dividend creeps up solely, the earnings creep up slowly, the stock price creeps up slowly. None of this seems to be a characteristic consistent with double-digit returns. But the high starting yield, combined with the perpetual march upward, create returns that are superior to what initially meets the eye. I study this stuff all the time, and I still underestimate the long-term wealth-creating power of the industry.
But hey, since I’ve started writing finance articles in 2011, every 100 shares of Southern Company have grown into almost 127 shares of SO with complete dividend reinvestment. I suspect that has something to do with it.
Notice: This article, which I believe may be of interest to readers, is for general information and entertainment purposes only. It only reflects my best understanding of the topic at hand and should not be relied upon as legal or investment advice.
Originally posted 2016-01-31 04:26:36.
