Investment Insider: Boring utilities but exciting returns

Water, gas and electricity can power your investment

In recent times, utilities have become attractive acquisition targets because of their reliable earnings.

For example, Asian tycoon Li Ka-shing snapped up Northumbrian Water in 2011 for around £4.7bn. The acquisition added the water asset to his portfolio of utilities that included a small stake in Southern Water and UK Power Networks, which was bought from France's EDF for £5.8bn.

Li Ka-shing said he was attracted by the regular returns of the UK power market.

Water companies continue to be eyed by professional investors. Severn Trent is the subject of a takeover by a consortium of UK and overseas investors.

At £20 a share, that would value the business at around £5bn excluding debts of about £4.1bn.

The interest in Severn Trent is obvious. It is a defensive investment that could deliver a reliable source of income for the consortium that comprises the Kuwait Investment Office, Borealis Infrastructure Management and the UK Universities Superannuation Scheme.

The deal for Severn Trent follows another deal last year in which BT's pension scheme bought a 13 per cent stake in Thames Water from Australia's Macquarie. As private investors, there is no reason why we should not consider including some reliable income-produc- ing regulated utilities in our portfolios too.

For example, Pennon Group, which provides water and sewerage services for Devon, Cornwall and parts of Dorset and Somerset, yields around 3.8 per cent. It can also boast a track record of dividend increases over the past five years.

Since 2009 it has raised its payout from 19.8p per share to 26.5p, which equates to an annual increase of around 8 per cent a year.

The ability to raise dividends consistently could be an important consideration for investors who are focused on yield on cost. For instance, in 2009, the average share price of Pennon Group was about 460p.

At the time the dividend yield was 4.3 per cent. But after four years of continuous dividend increases, the current payout of 26.5p would represent a yield on the original cost of the shares of almost 5.8 per cent.

The concept of yield on cost might be important for inves- tors whose intention is to buy a share and live off the divi- dends forever.

Apart from water companies, gas and electricity utilities may be worth considering.

SSE has targeted dividend increases as one of its key objectives. It intends to raise its payout by at least 2 per cent more than the rate of inflation.

In the past five years, its payout has increased at around 7 per cent a year from 62p to 81p.

It has been said that the time to sell utilities is in times of inflation or deflation; the time to buy or hold is in times of stagflation – which many commentators believe is happening today.

However, rules of thumb have their limitations.

A better rule might be to look for utilities that are run efficiently and have the ability to reward investors with decent dividends regardless of what the economy is doing.

David Kuo is director of fool.co.uk