Utility stocks weren’t the best investment in 2023. Despite reporting decent earnings and offering solid dividend increases, the utility sector lost about 10% last year compared to a 26% gain in the S&P 500.
In fact, if it wasn’t for dividends, utilities would have gone nowhere for the past two years. The payouts were the sector’s saving grace, underscoring why income investors repeatedly turn to these stocks. Dividends are why utilities have long been considered widows-and-orphans investments. You can always count on their income stream.
But 2024 is shaping up as a far different story. Utilities are one of the hottest plays around and are even outperforming the broad market index. This year, the sector is only behind tech and telecom stocks as the leading investment.
Artificial intelligence (AI) is the primary reason for the turnaround. Not only does AI require vast amounts of computing power, but it puts enormous demands on energy consumption. The Energy Information Administration says data centers are “one of the most energy-intensive building types, consuming 10 to 50 times the energy per floor space of a typical commercial office building.”
Utilities are now using AI to reduce the very high energy demands it is causing. While AI chips from Nvidia (NASDAQ:NVDA) are a foundational basis for the technology, the AI trade is now moving far beyond those narrow confines. Investors should look to utility stocks to play the next leg higher in the AI industrial revolution.
Entergy (ETR)
Entergy (NYSE:ETR) provides electricity to the Southeast. It is arguably one of the best-positioned utilities to capitalize on data center AI demands. Electricity costs are lower in the region than in much of the country. That’s key because the Electric Reliability Council of Texas recently said it expects a dramatic increase in electricity demand in the state over the next five years. The state’s electric grid could see some 152 gigawatts of demand by 2030, or double the level placed on it only four years ago.
Entergy is investing billions of dollars to upgrade its infrastructure. In Louisiana, for example, the utility intends to invest $1.9 billion in the first phase of its grid there to make it more resilient. The plan includes 2,100 projects that will reinforce critical structures in its transmission and distribution systems. Entergy also spends $1.46 billion on its 754-gigawatt (GW) Legend Power Station in southeast Texas.
Of course, Entergy faces one risk: storms in the Gulf Coast region. Hurricanes can cause billions of dollars in damage. Investors should consider if this risk is worth it. Entergy stock trades at 11 times trailing earnings and less than twice revenue. Look for ETR to be a unique AI stock to buy.
NextEra Energy (NEE)
Like Entergy, NextEra Energy (NYSE:NEE) is located in the Southeast and benefits from the region’s cost advantages. The utility stock has also invested heavily in renewable energy to become the world’s largest generator of wind and sun energy and a top-tier participant in battery storage.
NextEra Energy is also building out its project portfolio despite having substantial assets already in play. The utility has 65 GW of energy capacity at its disposal, some 36 GW of which comes from renewable sources. NextEra continues to add to it each quarter. There is about 3.5 GW of data center capacity and another nearly 3.5 GW in its backlog. It also has a pipeline of 250 gigawatts of renewables and storage in various stages of development.
The Florida-based utility runs some of the same risks as Entergy concerning severe weather. Although its stock has already seen tremendous gains this year, up 26% in 2024 and 63% over the past 12 months, the growth in AI demand suggests this utility stock is only just getting started in lighting up its capital appreciation opportunity.
Southern (SO)
Southern (NYSE:SO) is the third utility stock investors should buy to capitalize on the AI boom. And if you’re sensing a trend about location here, you’re not wrong. Hyperscalers are flocking to the Southeast, so utilities here are primed to win investments.
Alphabet’s (NASDAQ:GOOG, NASDAQ:GOOGL) Google is building a $600 million data center in a former semiconductor manufacturing facility in Tennessee. Meta Platforms (NASDAQ:META) recently announced it was building a new $800 million data center campus in Montgomery, Alabama. The Midwest is also a focus of new data center construction, with Google, Meta, and Amazon (NASDAQ:AMZN) building new facilities there.
Southern, though, is also investing in new projects to expand its generation capacity. However, it is focusing on nuclear energy. It put its Plant Vogtle Unit 3 into operation last July and just started up Unit 4 at the end of April.
Like NextEra, Southern’s stock has been part of the utility group driving the sector higher. Shares are up 14% this year and 30% above their lows. With the data center construction explosion, expect the utility stock to brighten up your portfolio.
On the date of publication, Rich Duprey did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.