As Energy Goes Greener, Utility Stocks Grow Fatter

The question isn’t if corporate tax rates are going to be increased under President Biden…

It’s how much.

No matter the answer, it’s going to be bad news for stocks.

Higher income taxes mean lower earnings. We have more than 100 years of historical stock market data that shows us that the true driver of stock prices is how much money companies make.

The most recent proposal projects that the corporate tax rate for companies with income of more than $5 million will increase from 21% to 26.5%.

That’s less than the 28% President Biden initially proposed, but it still means that most companies are going to lose 5.5 percentage points more of their earnings with the swipe of a pen.

I’ve seen estimates that combined other, prospective measures for Biden’s tax plan, and these forecasts show that S&P 500 companies could take hits to earnings of up to 9.2%.

If earnings drive stock prices, then a 9.2% decrease in earnings should have a proportionately negative impact on stocks.

So far, the market doesn’t seem to be pricing in Biden’s upcoming corporate tax increases.

At some point, I believe it will.

The worst-hit companies are expected to be those that have driven the market higher in recent years – the big tech leaders.

When investors realize this, it could spur a rotation out of tech and into other sectors.

If it does, I know where a big chunk of that money will go…

It’s the sector that will be the least impacted by corporate tax hikes – one that I previously identified as being a tremendous long-term fat pitch for investors.

A Long-Term Fat Pitch Protected From Tax Increases

In March, I identified the utility sector as a terrific way to profit from the long-term investment opportunity that is the “green revolution.”

These companies are both going green and profiting from the green movement.

My utilities investment thesis is simple.

As American drivers gradually stop fueling up their automobiles at the gas pump and instead start plugging into the electric grid, demand for electricity will rise. As a result, utilities will benefit.

That means, over the next 20 years, utility companies will spend tens of billions of dollars expanding their ability to generate power from more renewable sources.

Because these companies earn a set rate of return (established by public utility commissions) on what they have invested, these investments will drive earnings growth.

In recent years, earnings growth for the utility sector has been in the low single digits.

But in the coming years, the analyst consensus is that the sector will see steady annual earnings growth of almost 10%.

That may sound insignificant, but it’s more than enough for this sector to generate years of excellent returns.

Here’s why…

First, the market has to revalue these stocks to a higher valuation multiple that reflects their shift from no growth to strong, predictable, long-term growth.

While a no-growth company might be valued at 10 times earnings, a steadily growing company will be valued 50% to 100% higher.

That means there could be a 50% to 100% upside to utility stocks just from the higher valuation multiple once the market figures out the new rate of growth for the sector.

Second, on top of multiple expansion, there could be decades of nearly 10% earnings growth that will keep pushing stock prices and dividends higher.

To me, that sounds like double-digit returns from utilities for the next decade.

Now, about those tax increases…

Making the utility sector even more attractive is the fact that these companies are pretty much immune to looming corporate tax increases.

Since most utilities are regulated, they can simply request price increases from state public utility commissions to offset their increased tax bills.

That means utilities will slip the hit of the forthcoming corporate tax increases and pass it on to their customers.

That means your utility bills will likely go up.

But if you own utility stocks, you probably won’t mind!

Put this all together, and I see three clear reasons to own stocks in the utility sector for the long term…

1. The green revolution should drive strong earnings growth among utilities for the next 10 to 20 years.
2. This sector needs to be revalued for a higher rate of growth.
3. When the reality of corporate tax increases hits, money will flow into this sector, as it should be one of the least impacted.

I will even throw in one more reason to get excited about utilities…

As these companies transition from coal power to wind, their profit margins are going to increase.

The cost of land-based utility-scale wind in the central United States is now just $0.01 to $0.02 per kilowatt-hour. That’s less than half of the $0.04 to $0.05 per kilowatt-hour cost for coal-powered plants.

As coal plants are retired, and as wind and solar replace them, utilities’ earnings are going to go up even more.

Utilities – boring no more!