| Show J Should you buy utility stocks I By H Mark Holland Damn Bosworth representative We at Dam Dain Bosworth believe that utility ty stocks are doing as well today as they have at any time during the last ten years State utility commissions seem to better understand the profitability pressures that utilities have labored under for years and years are now gran- gran granting granting ting record rate relief Inflation and interest rates have drop drop- dropped ped sharply in recent months and utility stock prices have reached new highs In addition slower growth In electric de- de demand demand mand is easing the pressure on utility managements We think that this should result in better quality earnings and faster dividend growth In the next few years Furthermore despite l legislative ef- ef efforts efforts forts to repeal the favorable tax treat treat- treatment treatment ment of utility dividend reinvestment plans this feature has been retained by bythe bythe the latest Federal tax legislation A word or two should be said ab about ut the tax treatment of utility dividend reinvestment plans These plans have long been an attractive way for utilities to raise capital inexpensively as well as asa asa a convenient way for Investors to add to equity ownership in the utilities of their choice Prior to the Economic Recovery Tax Act of 1981 1961 tax deferred dividends were available solely from those utilities claiming that all or part of their dividends were a return of capital With few exceptions these companies were at the lower end of the quality spec spec- spectrum spectrum trum and therefore generally had poor earnings quality below average coverage ratios and relatively poor pro pro- prospects prospects for attractive growth The 1981 legislation made this Invest Invest- Investment investment ment mechanism more attractive by making such reinvestment of dividends tax free to the investor until any or or all of the original or reinvested shares are sold At the time of the sale if the shares have been held for at least one year past the date that the last dividend was paid then the dividends will be taxed at the capital gains tax rate The reinvested shares have a zero cost basis With very few exceptions virtually all electric utilities with dividend reinvest reinvest- reinvestment ment plans qualify to offer their in in- in investors these tax advantaged plans With the exclusion for individuals on reinvested dividends an Investor can maintain his tax deferred dividend status while upgrading to better quality issues and significantly Increasing his dividend growth prospects This legislation gives small Investors the ability to supplement estate building programs programs In amounts averaging a year with taxes deferred indefinitely as long as such investments are not sold In fact we think that the typical investor should view deferred taxation of utility dividends as part of an overall tax avoidance program That program should also where appropriate include the 2000 IRA account We think that investors who are in- in interested interested In utilities should be selective buyers We believe that they should choose utilities which combine both good quality and yield These better quality utilities should operate In favorable regulatory climates have ef- ef efficient efficient fuel sources generate strong in- in internal internal cash flow have reasonable con con- construction construction plans and maintain a sus sus- sus sustainable tamable dividend payout ratio Some market analysts su suggest est a dividend payout ratio of less than 75 of net in- in income Income come Dependence on oil and gas as fuel should be minimal seeking Income investors can still look lookin lookin in 12 10 10 12 yields in the majority of utility utility ty stocks As Interest rates decline it is likely that many investors will want to lock in the higher yields offered by the quality lower utilities However more conservative investors and those concerned about their current current- currently currently ly taxable income should stick with the higher quality lower yielding issues which should exhibit stronger dividend growth prospects In the future |
