What's the difference between a Ponzi scheme and a utility company? Before I answer that question, let's look at what a Ponzi scheme is. Wikipedia defines it as:
A fraudulent investment operation that pays returns to separate investors from their own money or money paid by subsequent investors, rather than from any actual profit earned. The Ponzi scheme usually entices new investors by offering returns other investments cannot guarantee, in the form of short-term returns that are either abnormally high or unusually consistent. The perpetuation of the returns that a Ponzi scheme advertises and pays requires an ever-increasing flow of money from investors to keep the scheme going.In effect, a Ponzi scheme pays yesterday's investors with money from today's investors. It works great until there aren't enough new investors to pay the old investors. In a similar manner, most utility companies rely on new capital either in the form of debt or equity to fund investment and to pay dividends.
For a company to consistently raise its dividends, it must generate strong cash flows sufficient to meet operating obligations and to service outstanding debt. When the day comes that these companies can not raise enough capital to fund the operating requirements, the first source of additional cash will likely come in the form of a lower or eliminated dividend.
So, back to the original question, what is the difference between a Ponzi scheme and a utility? The answer is simply disclosure. All public utilities make available via S.E.C. filings their cash flows including the source of cash. Unlike Bernard Madoff, these companies are telling you exactly what they are doing, thus there is no intent to defraud. I own some utilities, but I won't be rushing to add to increase my positions.
Caveat emptor!
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