Most utility stocks pay a dividend, thanks to the regulated and resilient nature of utilities that allows companies to generate steady, often predictable, revenue and cash flows. Utility stocks, therefore, often make it into the portfolios of income investors.

However, one mistake investors make is chasing dividend yields. That's not to say a high yield isn't better, but overlooking stocks just because their yields aren't that great could mean missing out on big returns. That's what I found out when I dug deeper into dividend-paying utility stocks, which is why the three utility stocks I've picked here have two themes in common: world-class dividend payout and dividend growth track records.

This stock almost assures high annualized returns

Duke Energy (NYSE:DUK) is one heck of a dividend stock if you're looking to invest in a traditional utility. Here's why:

  • It's one of the largest electric power companies in the U.S. in terms of customer base.
  • It is the second-largest publicly listed company in terms of market capitalization, as of this writing.
  • It's a 95% regulated electric and gas utility.
  • It yields 4.2% today.

As a regulated utility, Duke can hike tariffs at regular intervals provided it spends enough on infrastructure to win tariff hike approvals from public utility commissions. At its recent inaugural ESG investor day, Duke outlined plans to invest $58 billion between 2020 and 2024 and $65 billion to $75 billion between 2025 and 2029, with greater focus on clean energy. Duke believes this program should help it hit the higher end of its projected adjusted earnings per share (EPS) growth rate of 4%-6% through 2024.

A gold star trophy on  table.

Image source: Getty Images.

That earnings growth, combined with Duke's target dividend payout of 65%-75%, should ensure higher dividends year after year. So far, Duke has increased dividends every year for the past 14 consecutive years. Assuming an average annual dividend hike and yield of around 4% each, you could lock in high-single percentage annual returns on Duke shares, and even more, during volatile times.

Watch out for this earnings report

American Water Works (NYSE:AWK) effortlessly proves how a boring stock can be a multibagger. Credit goes to consistent earnings and dividend growth, underpinned by a highly regulated business model.

AWK Chart

AWK data by YCharts

American Water provides water and wastewater services to nearly 15 million customers across 46 states. The company has increased dividend every year since its initial public offering in 2008. The best part is that its dividend growth rate has picked up pace in recent years, with the company gifting shareholders a solid 10% dividend increase in 2020.

That dividend streak is here to stay. Through 2024, American Water projects dividend to grow at a compound annual rate of 7%-10%, powered by similar growth in EPS. The company is targeting capital spending worth $20 billion to $22 billion over the next decade, which should serve two purposes: help American Water convince regulators to approve higher tariff, and exploit opportunities in the fragmented water industry in the U.S.

Last quarter, American Water bumped up its 2020 guidance projecting nearly 14% growth in EPS. With its earnings around the corner and a dividend hike due in a couple of months, American Water is likely headed for another strong year after a bumper 2020.

Best bet on renewable energy

NextEra Energy (NYSE:NEE) offers the best of both worlds: a traditional utility with growing clout in the the renewable energy industry. NextEra owns the largest regulated utility in the U.S., Florida Power & Light Company, and is the world's largest producer of energy from wind and solar. Importantly, it is one of the best dividend growth stocks you could find in the industry today.

NextEra is on high growth trajectory right now. In 2020, NextEra added record 7 gigawatts (GW) of renewable energy projects and expects to construct 23 GW to 30GW between 2021 and 2024. After growing its adjusted earnings per share by 10.5% in 2020, NextEra projects adjusted EPS to grow 7% at the midpoint in 2021, and between 6% and 8% annually through 2023. CEO Jim Robo even stated he'd be disappointed if NextEra doesn't hit the top end of its adjusted EPS guidance through 2023. That should mean big dividends as well: Management projects 10% annual growth in dividend per share through "at least" 2022.

NextEra's dividend growth is the biggest reason why you should look beyond the stock's small 1.7% yield, because that growth is also the biggest factor behind the stock's blistering run up in just the past decade.

NEE Chart

NEE data by YCharts

Dividend growth: The key to selecting utility stocks

By now, you'd have figured what powered up the rally in Duke Energy, NextEra Energy, and American Water Works stocks over the years: It's the stability and growth in their dividends. If you keep that in mind when selecting utility stocks to invest in, you'd be able to build great wealth even from this boring sector.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.