3 Best Stocks to Invest in Water

I'm going to gush about water utility stocks, which in my opinion will remain one of the best places to grow money over the long term, particularly as part of a dividend-reinvestment portfolio. These stocks have been getting a bit more love recently thanks to California's epic drought.But the topic still doesn't receive the coverage warranted by select water stocks' powerful combination of market-beating long-term returns at less than average risk.

Source: Davide Restivo via Wikimedia Commons .

Spouting off the reasons to love water utilities

  • They're generally monopolies.
  • Water supply is limited -- and will likely shrink, as the Earth has been in a long-term warming trend.
  • Demand should grow as the world population increases and as a greater percentage of the population moves into the consuming classes.
  • Water has no substitutes.

Water Utility Stocks with Market Caps More Than $300 Million

Sources: Yahoo! Finance and Morningstar. Data to April 10. Excludes Companhia de Saneamento Basico de Sao Paulobecause it's a Brazilian company.

Only 13 water utility stocks trade on major U.S. stock exchanges. That's because the water utility industry in this country includes many public entities..

The first two best waterutility stocks: American States Water and American Water WorksSize is a key attractive feature of both these stocks. Smaller companies in many other industries -- particularly technology -- often have more growth potential than their larger brethren. However, water utilities are generally a bit of a different beast. This is a very fragmented and capital-intensive space, so the bigger players should continue to have an advantage because there's much potential for consolidation.

American States Water: drought territory plus services niche

American States primarily operates as a regulated water utility in California, though it also provides electric service to the Big Bear Lake region. Additionally, it has a nonregulated business that operates and maintains water and wastewater systems on military bases throughout the United States. Its public utility territory includes areas where agricultural and other water demand should continue to increase due to more frequent and severe drought conditions.

This company haspaid dividends every year since 1931, increasing the payout each year since 1954. Its dividend ratio is 48% -- the lowest among the stocks in the chart, excluding SJW, which isn't a pure play as it has significant real estate operations. This ratio is the percentage of net income paid to shareholders in dividends. A payout ratio of less than about 70% indicates the possibility of future dividend increases.

The stock's 12.2% return on equity is among the group's highest, while its debt-to-equity ratio of 0.64 is the lowest among the stocks in the chart. Over the most recent10-year period,the stock's total return is 326% vs. 120% for the S&P 500.This long-term superior performance suggests the company is well run. Investors will have to pay up for these features, as the stock has the highest valuation among the water utilities, with a five-year PEG (P/E to growth) of 8.2. For context, American Water Works has a PEG of 2.7.

American Water Works: the industryheavyweightAmerican Water Works operates in more than 45 states and one Canadian province. Its regulated business provides water and wastewater services, while its nonregulated segmentbuilds, operates, and maintains water and wastewater facilities for military bases, municipalities, industrial customers, and others.

There's much to like about the industry's largest player, particularly if you're a conservative investor. The company's size means it is likely to continue to gobble up smaller water companies throughoutthe country. Analysts expect its earnings per share to grow at an average annual rate of 7.8% over the next five years, which is the highest growth rate among the water stocks in our chart. The company's payout ratio is an attractive 51%.

Stock No. 3: Aqua America York Water was in the running for the bronze thanks to some attractive features, so it's worth exploring. However, Aqua America's size was largely the deciding factor, as its potential for long-term growth is likely greater. Both have been two of the better long-term performers in this group.

Aqua America provides water and wastewater services to customers in Pennsylania, Virginia, North Carolina, Illinois, New Jersey, Indiana, and Texas. Additionally, in 2012 it began supplying water to energy producers for hydraulic fracturing -- "fracking" -- in the Marcellus shale region of Pennsylvania. The Pennsylvania-based company's March dividend marked the70th consecutive year the company has paidquarterly dividends. It has increased the payout for 23 consecutiveyears. The company's profit margin is 29.9%, the highest among the water utilities.

The final drop...Demand for fresh water should increase as the population grows and more people around the globe move into the middle class. Likewise, the Earth's warming trend should increase demand, while decreasing supply due to more frequent and severe drought conditions in certain geographic areas.Given water is a finite commodity and there are no substitutes, select water utilities should benefit.

Investors should realize that select waterutility stocks have run up in price over the last year, making themhighly valued.So these stocks are best suited for those with a longer investment time horizon..

The article 3 Best Stocks to Invest in Water originally appeared on Fool.com.

Beth McKenna has no position in any stocks mentioned. The Motley Fool recommends Aqua America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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