Volatility has greatly increased in the stock market lately, primarily due to the fear of investors that the Fed may raise interest rates too aggressively and thus it may hurt the economy. Consequently, it is only natural that many investors are looking for stocks that are resilient to recessions. Water stocks are among the most resilient stocks to recessions thanks to the essential nature of water. Even under the fiercest economic conditions, people do not reduce their water consumption. In this article, we will analyze the prospects of two high-quality water stocks, namely California Water Service (CWT) and Essential Utilities (WTRG).

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California Water Service

California Water Service is the third-largest publicly-owned water utility in the United States. Through its subsidiaries, it provides water to about two million people, mainly in California, with some additional operations in Washington, New Mexico, and Hawaii.

California Water Service faced two strong headwinds last year, namely the coronavirus crisis and severe drought conditions in California, which led the Governor to impose limits on water consumption during the summer period. Nevertheless, the company proved once again that it is one of the most resilient companies to downturns. Despite the pandemic, the company achieved record earnings in 2020 and grew its earnings per share by another 2% in 2021, to a new all-time high.

Moreover, the utility is in a reliable growth trajectory thanks to the regulated nature of its business. On the one hand, regulatory authorities refrain from approving of extreme rate hikes in order to put a lid on the price of water and thus keep consumers satisfied. On the other hand, regulatory authorities have to approve of material rate hikes year after year in order to provide an incentive to California Water Service to continue investing in the expansion and maintenance of its network.

Thanks to the reliable rate hikes approved by regulators and the expansion of its network, California Water Service has grown its earnings per share at a 6.7% average annual rate over the last decade. This is certainly an attractive growth rate for a utility stock, especially given the defensive nature of the stock.

The rock-solid business model of California Water Service has helped the company achieve an exceptional dividend growth streak. The company has raised its dividend for 54 consecutive years and hence it is one of the 31 Dividend Kings. Given its solid payout ratio of 45% and its reliable growth trajectory, it is safe to expect this utility to continue raising its dividend for many more years.

On the other hand, the stock is currently trading at a price-to-earnings ratio of 31.0 and is offering just a 1.5% dividend yield. In other words, the market has already priced a great portion of future growth in the stock. Therefore, dividend growth investors should wait on the sidelines for a more opportune entry point.

Essential Utilities

Essential Utilities is the second-largest publicly traded water utility in the U.S., serving approximately 5 million customers across ten states. In 2020, it acquired People’s, a natural gas distribution company and thus diversified its business.

Just like California Water Service, Essential Utilities has proven rock-solid during recessions and bear markets. It has also exhibited a consistent growth record thanks to the acquisition of smaller water utilities and the rate hikes approved by regulatory authorities. Essential Utilities has grown its earnings per share by 7.4% per year on average over the last decade. It has also proved resilient to the pandemic, as it grew its earnings per share by 7% in 2020 and by another 6% in 2021, to a new all-time high.

Thanks to its consistent earnings growth, Essential Utilities has raised its dividend for 30 consecutive years and thus it is a Dividend Aristocrat. Given its healthy payout ratio of 64% and its predictable growth prospects, the company can easily keep raising its dividend for many more years.

On the other hand, the stock is currently trading at a price-to-earnings ratio of 28.6 and is offering a dividend yield of only 2.2%. As a result, investors should wait for a meaningful correction of the stock before purchasing it.

Final Thoughts

Competition has heated more than ever in almost every sector in recent years. Consequently, it has become challenging to identify stocks with a wide business moat. Thanks to the regulated nature of their business, water stocks have one of the widest business moats in the investing universe. They are also resilient to recessions and hence they are ideal candidates for the portfolios of income-oriented investors. The only caveat is their rich valuation right now, which means that investors should wait for a correction of these defensive stocks.