The media is currently hyping utility stocks as a smart investment option to benefit from the growth of artificial intelligence (AI). Headlines from prominent sources such as The Wall Street Journal, CNBC, and Barron’s are promoting utility stocks as a hot bet in the AI market. However, contrarians caution against chasing headlines and advise focusing on value and high-yielding stocks that are undervalued.
Utility stocks are often considered “bond proxies” due to their tendency to rise as interest rates fall. Consequently, during a period of declining interest rates, investing in utilities can be a profitable strategy. The recent trend in utility stocks has shown a correlation with the 10-year Treasury rate, with a notable rise in the Utilities Select SPDR ETF (XLU) when interest rates hit a low point.
With the Federal Reserve signaling a potential rate-cut cycle in response to factors like decreasing inflation and rising unemployment, the window of opportunity for investing in utilities remains open. However, investors should be cautious and avoid overvalued options like XLU. Instead, focusing on lesser-known investments like the Reaves Utility Income Fund (UTG), a closed-end fund with a high yield of 8.2%, can be a profitable choice.
The growth of AI is expected to lead to a surge in power demand as data centers require more electricity to operate. Goldman Sachs predicts a 15% annual growth rate in data center power demand from 2023 to 2030, which will significantly impact the nation’s power grid. Government investments in infrastructure projects, including grid upgrades under the Bipartisan Infrastructure Law, are likely to support the expansion of the power sector to meet AI-related demands.
In addition to AI, the electrification of various industries, including the rise of electric vehicles (EVs), is expected to increase power demand significantly in the coming years. The International Energy Agency forecasts that the global EV fleet could comprise 6% to 8% of global power demand by 2035, presenting substantial opportunities for utilities. Investors are advised to consider utility stocks like Dominion Energy (D), which offers a rich dividend yield of 5.3% and stands to benefit from the increasing power demand driven by data centers and EVs.
Dominion Energy, despite facing challenges like a dividend cut in 2020 due to high debt levels, has made significant progress in reducing its long-term debt and positioning itself for growth. As interest rates are expected to decline, the company’s borrowing costs may decrease, allowing it to allocate more resources to meet the rising demand for power. Overall, the electrification trend presents a lucrative opportunity for utilities, and investors are encouraged to explore options like UTG or individual stocks like Dominion Energy to capitalize on this growing market.
