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Unfortunately National Grid is a bit more complicated because it earns a large chunk of its money in America where the kind of extra information I need is not very easy to find. By looking at its regulatory accounts I would be able to get a good idea how much it needs to spend to maintain its grids and how much cash is left over for dividends. Ideally, I'd like to do the same kind of analysis I did on the UK water companies with National Grid.

When I looked at UK water companies, this is what I found to be happening.

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This means that the lack of free cash flow is often not a problem. The company will then borrow money to finance the growth capex, safe in the knowledge that it can recover the money from customer bills in the future.

The money left over after maintenance capex can be used to pay a dividend. Essentially a company will look at its spending plans and break down its investments into an amount needed to maintain its assets (maintenance capex) and an amount needed to grow them (growth capex).

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It doesn't necessarily mean that a company is overstating its profits and having to resort to borrowing to pay its dividend.īack in September this year I wrote an article about how to analyse water companies (click here to read this) and explained that a company's dividend policy was based on taking a five year view of its cash flows.

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I used to know professional fund managers who wouldn't for exactly this reason.īut utilities may be an exception to this rule.įree cash flow will always be a little bit hard to come by when a company is spending a lot of money growing the size of a gas, electricity and water network. If you are a stickler for companies that produce lots of free cash flow then you probably won't invest in utility shares like National Grid. I've been writing a lot about the importance of free cash flow in recent weeks. By paying for these assets with cheap loans, National Grid has been able to make more money and pay bigger dividends to its shareholders (see chart below). The amount of money it has been spending on these things has been rising in recent years as worn out assets have been replaced and new sources of electricity (wind farms and solar panels) and gas have been connected to its grids. National Grid makes money by spending money on new wires, pylons and pipelines. Unlike a power station or a gas field, National Grid's profits are not very dependent on the market price of electricity or gas (which has been falling). This means that it has enough money to spend on the grids and still have enough money left over to pay the interest on any money it has borrowed, the taxman and a dividend to its shareholders.

In return for keeping them in good condition and connecting more gas and electricity to households and businesses, National Grid is allowed to charge its customers a fair price. Because gas and electricity are an essential part of our daily lives, the business of looking after these grids is regulated. The company owns and looks after gas and electricity grids in the UK and USA. On top of this, it would seem that National Grid is a very safe business to invest in.

In a world where savings accounts and government bonds pay miniscule rates of interest it's not difficult to see why more investors have been snapping up National Grid shares with a dividend yield of around 5%. It seems there's a lot to be happy about. During the last five years the share price has almost doubled whilst the company has been paying out some very chunky dividends. National Grid shares are very popular with investors.