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By Travis Miller | 05-09-2016 02:00 PM

Dodge the Yield Paradox With These 2 Utilities

Despite the runup in utilities stocks this year, Duke Energy and Dominion are reasonably priced, higher-yielding choices in the sector, says Morningstar's Travis Miller.

Travis Miller: Utilities sector investors are caught in what we're calling the yield paradox right now. The sector is up 14% year-to-date, well above any other sector and trouncing the S&P 500's 1% year-to-date return.

This we think leaves this sector 13% overvalued, and valuation multiples are trading at historic highs. All of this points to a bearish outlook. But when you look at the dividend fundamentals, they look very good. With U.S. Treasury rates trading below 2% yields and utilities' average dividend yields up at 3.7% right now, the yield environment is very good for utilities investors. The 190 basis points spread right now between treasuries and the dividend yield is at an historic high, representing a very good value for income investors right now.

Two of the names we like that take advantage of that high dividend yield are Duke Energy, large-cap U.S. regulated utility. It's one of the few that yields over 4% right now and trades at a slight discount on a valuation multiple basis to its peers. We like its growth opportunities with 5.5% earnings growth and $42 billion of investment opportunities over the next five years.

We also like wide-moat Dominion as one of our few wide-moat utilities, and 50% of its earnings we think will come from wide-moat gas pipelines, electric transmission and a liquefied natural gas export facility at Cove Point. It also yields near 4% right now with strong earnings growth potential.

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