Home Beginner Market Structure What Is Utility Sector & What Does It Comprise Of ?

What Is Utility Sector & What Does It Comprise Of ?

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Introduction to the Stock market

Most of the counties have their stock market where the companies go public and offer their shares to everyone. There are a truckload number of stocks in developing and developed countries. Keeping an eye on all the stocks is difficult. Hence, the stock market is usually classified based on the company’s market capitalisation and the sector they belong to. Focusing on the sectors, the different sectors in a country are Financials, Utilities, Consumer Discretionary, Consumer Staples, Energy, Healthcare, Industrials, Technology, Telecom, Materials, and Real State. Going forward, our discussion will be confined to the utility sector.

What is the Utility Sector?

When it comes to income-producing stocks, the first thing that clicks in the people’s mind is the utilities. The utility sector comprises of the stocks of the companies that provide services such as water supply, electricity transmission, airport, dams, and gas delivery. Typically, utility stocks are the highest-yielding stocks in the market.

Before getting into detail about the utility sector stocks, let us first understand the term utility

Basically, Utilities are the service providing companies that provide the resources to run a building. The utilities are classified into

  • Electric companies: These are the companies responsible for the generation, transmission, and distribution of electric power. There are utility companies that are integrated such that carry out all the three processes under one roof. While sometimes, generation and transmission can be separate companies, but both are related to each other. The generation of energy could be through any of the renewable or non-renewable sources such as solar power, nuclear energy, wind power, and even burning coal. And, transmission and distribution rely on power grid and lines.
  • Natural gas companies: These are the companies that provide heat energy to the homes, mainly for cooking purposes. They’re often aligned with the electric companies, as natural gas is used to produce electricity. Also, these companies remain monopolies are in the business as these companies always earn profits and pay a dividend to their investors.
  • Water companies: Water is the most important resource for every household. Hence, water companies are the companies which are responsible for distributing water for drinking and household purpose, providing piping facility and removing sewage throughout the community. In most countries, water companies are run by local municipalities. There is always a massive demand for water. But, water supplies are getting scarce across parts of the counties. This rise in demand implies better growth for water companies.

More about the Utility Sector

We have seen that the utility sector is always in demand. This results in the company’s stock to perform well in the market. They often earn good profits, and hence, they are regular dividend payers. Therefore, investors invest in such companies having a long term perspective due to their stability and dividend income.  In this sector, there are different types of companies based on their size. For example, large utility companies usually offer electricity and natural gas supply. While the small utility companies, only provide one of the three facilities.

Impact of competition in the Utility Sector

There are quite a lot of utility companies in a country. Now, the consumers have a choice to choose their own utility company for their needs. Usually, the consumers choose the utility company with the least cost and most amount of benefit. Since there are many utility companies, to attract consumers; they need to reduce their prices. And this reduction in the price decreases their profits. Hence, competition in the utility sector has a negative impact on companies.

Investors’ view on the Utility Stocks

The utility companies are known for their dividend payment and stability. So, these stocks compete with those stocks that pay comparatively lower dividends. Also, these companies are not badly hit against macroeconomic downturns. Hence, the investors see these stocks as a protective type of stocks. However, this might not be the best option of investment when there is a rise in the interest rates as the bonds seem to perform better than the utility stocks. So, an investor would prefer investing in bond markets rather than the utility stocks.

Advantages of investing in the Utility Sector Stocks

  1. They rarely go out of business: Utility sector is that sector which is required by every citizen to fulfil their basic needs. Therefore, these companies get consistently to get revenues from customers. Hence, it is almost impossible for their business to go bankrupt. They usually stay on the profit side of things.
  2. 2. High dividend payers: As discussed previously that these companies are always in profit due to its requirement by everyone; hence, they pay out a large sum of their earnings to the investors. They usually pay about 60 to 80 per cent of their earnings to their shareholders. And, an average return from these stocks is between 10 to 12%. These companies are such companies that rarely cut dividends. In fact, they consistently keep hiking dividends.
  3. They’re big-time monopolies: Strictly talking about the generating utility sector, construction of power plants for the generation of resources requires huge capital investment. And this capital is not possessed by most of them. Hence, this reduces competition, and the companies with the power plants are the only ones ruling the business. And hence, increases their profit tremendously.
  4. The utility sector stocks offer stable and quite significant long term returns.
  5. Investing in the utility sector is considered one of the safest investments as these stocks do not see drastic falls during economic downturns.

Disadvantages of investing in this sector

  1. If the government intensifies its regulatory towards the utility sector, it causes difficulty in raising customer utility prices. Hence, their revenues don’t seem to increase.
  2. As already mentioned earlier, an increase in the interest rates does not attract the investors as they look forward to investing in the bond yields than this sector.

Utility Sector ETFs

Investors who are keen on investing in this sector can consider investing in their ETFs. For example, the Utilities Select Sector SPDR Fund is one of the largest utility ETF in the US. This ETF is also very active in the market, and hence, one can consider investing in this ETF as it pays regular dividends as well.

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