Question: I'm considering buying some utility stocks. Anything special I should know?

George Lowrey

Answer:

Dear Mr. Lowrey,

You won't be alone. Investors are often attracted to utility stocks because of their traditionally high yields. However, the plus of high yields come with a downside, one you should be aware of - that this industry is extremely sensitive to interest rates and behaves quite like bonds. In other words, when interest rates rise, share prices tend to head down and when rates drop, stock prices tend to rise.

On the other hand, we all need energy, so in that respect the industry has a monopolistic position.

Here are several tips to keep in mind as you search for the right stock for your particular portfolio...

• Management. Select a company that has a strong management. To help you make this evaluation, read the independent research reports in Value Line Investment Survey (www.valueline.com) as well as the company's annual and quarterly reports.
  
  
• Dividend. Is the dividend well covered by earnings?
  
  
• Debt level. As we always advise in this column, you want a company that does not carry a burdensome, long-term debt load.
  
  
• Energy source. Nuclear and water energy are generally cheaper than coal or natural gas.
  
  
• Publicly known problems. If a utility has a negative event, such as a major brownout, blackout or strike, it's stock is likely to immediately tumble. One such event, however, will not ruin a company provided the situation is properly managed. Therefore, look into the company's history - if major problems appear to be ongoing, you'll want to avoid the stock. Another way to address this situation is to buy shares in more than one utility, thus offsetting any damage that may take place in one particular company.
  
  
• Excess cash. Check to see how much cash the company has on hand and where it is invested.
  
  
• Reserve margin. What is the power capacity above peak-load usage? If it is especially high, the company may have unused plants and high costs. The industry-wide average is around 25%.
  
  
• Bond rating. You should also study the utility's bond rating, as issued by Standard & Poor's or Moody's. A company's bond rating is a realistic measure of the company's financial strength.
  
  
• Ownership. Check out the percentage of stock owned by management. Then select a utility in which management has expressed its confidence by purchasing shares.

Finally, consider purchasing utilities headquartered in different states. Doing so protects you from any onerous regulatory rulings and provides further diversification.

Good luck!