Experts warn of threat to income dividend from utility shares Omitting these often significant drains on cash gives investors an incomplete picture of a company's health, the managers said. "We look at what's left in the till after the company has paid every claim, including debt interest and dividends," Mr Godber said. Applying the Miton managers' technique to Britain's utilities makes for sobering reading. Five of the six companies they looked at turned out to have negative cash flow when all payments were taken into account. SSE, formerly known as Scottish & Southern Energy, will have a positive "headline" cash flow of 3.8pc this year, according to analysts' forecasts compiled by Bloomberg. However, it will pay a dividend yield of 5.38pc. After all costs are taken into account, Ms Hamilton calculated that it would lose cash to the tune of 4.5pc. In other words, it will pay its dividends out of borrowings, rather than from cash generated by the business - as it has since 2008, the managers said. True cash flows to SSE shareholders have been negative since 2004 and as a result the company's debt has risen relative to equity every year except 2011, when it raised money by issuing more shares. Of the six quoted utilities analysed by Mr Godber and Ms Hamilton, only Centrica will manage to retain cash this year, at a rate of just 0.4pc, while the figures for retained cash flow at the three water companies are well into negative territory - minus 10.7pc at Pennon, minus 5.8pc for United Utilities and minus 1.8pc at Severn Trent. National Grid's figure is minus 5.8pc. Mr Godber said: "Centrica has been generating cash. If I had to own a utility stock, that would be the one. Referring to National Grid, he added: "The switch from coal-fired power stations in the north of England to coastal wind farms means that the company is rewiring Britain. It is spending vast sums on this but its financial returns are protected by regulation. Its debt is rising but it's not as bad as the others. Mr Luthman said he and his co-manager on Liontrust's "Macro" fund range, Steve Bailey, looked at the wider economic situation to choose stocks, as opposed to the Miton team's detailed analysis of companies' books. But he agreed that the utilities' profitability was "largely illusory." He added: "Paying dividends from debt is something I'd normally associate with deep recession - housebuilders have done this at times, for example. When it happens, it rings alarm bells. Mr Luthman said the power industry's construction of wind farms amounted to duplication of existing generating plant, which was still needed as backup. The power firms don't get a single extra customer or sell a single extra unit of electricity from building these renewable stations. The commercial case is a complete nonsense. Who meets the cost? A mix of taxpayers, energy consumers and investors. Which of these will cost the government of the day the fewest votes if they are forced to bear the brunt? The shareholders. He added: "We are not saying that the power companies will go bust, but warning that the political risks are not reflected in their valuations. These valuations don't reflect reality - commercial or political. The shares are priced as if the companies had the potential to grow, but no one is going to turn the heating up in a recession. And when the economy does improve, interest rates will rise, making the yield less attractive. He said this last point also applied to water firms. As we said, utilities are attractive to income-seeking investors. So what does the most respected equity income investor of all, Neil Woodford of Invesco Perpetual, think of them? He holds shares in four: a very large stake in Drax, which runs coal-fired generating plant; a 7pc stake in Centrica; a relatively small holding in SSE; and some securities that pay dividends from the nuclear stations of the former British Energy. He sold his stakes in National Grid and the water companies "a couple of years ago," said William Deer, UK product director at Invesco. Mr Deer said these "regulated" firms had rates of return set by regulators that weren't appropriate to the risk - "we could get better risk-adjusted returns elsewhere." Peter Atherton, an analyst at Liberum Capital, said: "Utility shares have done well up to now, thanks to the search for income. They are now fully valued. Over the medium to longer term I would say sell.