Before Enron fell, even the sleepiest utilities felt compelled to change the way they did business for the “new era.” Today, the focus is back on the basics of running good businesses, meaning efficiently providing solid power, gas, water and communications service.

During the Enron Era, utility managements piled on the debt to build everything from new power plants to broadband capacity and the result was a colossal supply glut of everything, which in turn drove down prices to depressed levels. That debt then became unmanageable for many companies, with the result of a wave of dividend cuts and dramatically lower credit ratings.

Today, the supply glut is being rapidly soaked up in all utility industries and companies are building again, even as they pay down debt. VERIZON COMMUNICATIONS (NYSE: VZ) continues to successfully roll out its nationwide fiber optic network for wireline broadband, even as its wireless unit expands capacity and services. Wireless spectrum is in high demand. Water companies continue to make acquisitions at a feverish clip, as are energy infrastructure outfits. Energy utilities are drilling more oil and gas.

At the same time, S&P is issuing a record number of upgrades in both credit ratings and credit outlooks. The agency noted that the second quarter was the best for rating upgrades in “many years.” That’s a clear confirmation of utes’ success in getting their acts together financially over the last four plus years.

The collapse of Enron marked the low point in a year (2001) of unprecedented degeneration of utility/regulator relations.

California then made its demand for $9 billion in damages from power producers to compensate for the spike in power prices from the previous year--money the companies simply did not have. And several other Western states were following its lead with their own lawsuits. The Commodity Futures Trading Commission was piling on with its own version of market manipulation investigation in the rest of the country.

In stark contrast, today’s utility/regulator relations are as positive as they’ve been at any time since the ‘60s. Even in states in line for major rate increases--such as Maryland and Illinois--regulators and politicians have been mindful of utility credit quality. The legislation that passed in Maryland over the governor’s veto wasn’t ideal in that it fired the state’s Public Service Commission and undermined the governor’s historic power to shape regulation. But it did allow for full recovery of CONSTELLATION ENERGY’S (NYSE: CEG) power costs will no direct hit on earnings. Illinois, meanwhile, is going through with a power auction and looks set to implement at least some of the promised rate increases that go along with it.

The greatest risk for most electric utilities in the next five years is that Congress or the courts will impose extremely onerous regulation of their CO2 emissions. The catalyst could be a decision by the courts to force an extra-legislative solution to implement harsh controls.

As I wrote two weeks ago in Utility & Income, there’s now a movement among utilities and other industries to head that off by getting the current Congress to enact legislation for a relatively benign “cap and trade” system. This would allow some to continue emitting CO2 by purchasing credits from utes that reduce their CO2 emissions. This is the same system used to successfully reduce acid rain-causing SOX and NOX in the US. It’s already being employed in Europe for CO2 and, ironically, one of the beneficiaries is EXXONMOBIL (NYSE: XOM), which is squarely in the anti-CO2 regulation camp in the US.

The result should be that CO2 regulation is a financial disaster for neither utilities nor the US economy. In fact, because regulated utility rate bases increase with investment--including that designed to reduce pollution--it could actually help increase earnings for some.

Perhaps the biggest difference between now and then is management caution and skepticism. At least in the utility industry, executives are less likely to follow strategic moves used by their fellows.

The only exception is mergers and acquisitions, which are heating up again. In the past couple of weeks alone, we’ve seen the acquisition by WPS RESOURCES (NYSE: WPS) for troubled PEOPLES ENERGY (NYSE:PGL). Also, MDU RESOURCES (NYSE: MDU) has inked a deal to buy CASCADE NATURAL GAS (NYSE: CGC) and a private capital firm is gobbling up DQE (NYSE: DQE). The theme is primarily larger players gobbling up smaller ones, punctuated by the occasional attempt by investors to snap up an undervalued bargain, as is the case with DQE.

It’s too soon to say if last year’s repeal of the Public Utility Holding Company Act will really set off a frenzy of takeover activity or whether it will lead to less creditworthy ownership of utilities. But thus far, the tenor has been considerably more sane than the frenzy of activity in the ‘90s, when companies were merging but also creating operations in areas outside their core businesses--like energy marketing--which later came back to burn them. In fact, it looks like most deals are designed to increase economies of scale, which has always been a plus in power.

The most telling evidence of how far we are from the Enron collapse is how utilities have performed in the stock market. 2002 was an even worse year for many companies, as the after shocks of the failure of the industry’s biggest player were felt. By the end of that year, some two dozen utilities were at risk of bankruptcy and the Dow Jones Utility Average traded at barely 40 percent of its highs in late 2000.

Since then, utilities have staged their most dynamic rally since World War II. And while the averages have given back some of that in the recent market turmoil, the strong are still trading at levels well above the 2000 highs, and even the weakest are trading at several times their lowest levels. Even extremely volatile interest rates this year haven’t been able to crack utilities’ strength, as they remain one of the best performing groups in the market.

Now with earnings growing, valuations have come down dramatically from their levels of the September peaks. And with more growth expected this year--in both earnings and dividends--the best of the group is setting up for another leg up. That could come very quickly, if interest rates start to head south, or if the market continues what appears to be a rush to quality.

But no matter what happens with rates, utilities will hold their own as long as fundamentals stay strong. And that looks virtually certain for at least the next few years, and probably a lot longer.

After all, total meltdowns of the 2001-02 variety have occurred only once a generation, the last crusher being in the 1972-74 period.

LESSONS LEARNED

There’s nothing like a multi-year rally to calm the nerves and bury old sins. My own from the 2001-02 bear market were not as great as those of some--Utility Forecaster was credited in Forbes as one of only five investment newsletters to recommend selling Enron before its final death plunge--but they were painful enough.

The 2001-02 bear market was easily my toughest period in the investment business. Not every recommendation, of course, was losing money. In fact, my Income Portfolio collection of bonds, preferreds and very safe “old school” utility stocks actually made money in both 2001 and 2002. But many of the stocks I’d talked about most in the ‘90s--for their growth potential--were among the worst performers in the bear market.

For the 20 years-plus I’ve been in this business, I’ve always fielded subscriber correspondence personally. This was not a pleasant pastime in the 2001-02 bear market. Utility Forecaster readers were losing money. I faced a daily barrage of letters, phone calls and e-mails from subscribers who were alternately despondent, worried and/or angry with me. The volatile downward-biased market action forced me to make almost daily decisions on whether to advise pulling the plug on certain stocks. And I can’t say I always responded correctly, holding onto some too long and selling others at or near their ultimate bottoms.

One of the oldest maxims in the investment advisory business is you always feel the worst at the bottom; the problem is you don’t know how much lower you’re going to go first, i.e. how much worse you’re going to feel. As it turned out, late 2002 was the bottom. And since then, things have consistently turned up. Those who stuck with UF and followed the letter’s advice have not only healed their wounds, but have enjoyed some of the best returns ever enjoyed in any market, particularly for income-oriented stocks.

For me, however, the memory of the 2001-02 bear market still looms large, and I’ve resolved to keep the lessons learned close to me.

Lesson one from the Enron crackup is your worst bear market losses always come in a few situations where fundamentals have cracked up.

The companies stay healthy may also lose ground, but they’re going to come back. There’s no such assurance for companies whose businesses are melting down.

All utilities certainly felt some pain during 2001-02, with very few exceptions. That’s typical, since investors will tend to sell off all the stocks in a sector when it’s weak. And it’s generally best just to hold on at such times if you’re a long-term investor and particularly if you’re looking for income.

My mistake was hanging onto companies after they showed fundamental weakness as well as market weakness. For example, had I unloaded Aquila, Mirant and WorldCom when I first noticed earnings starting to buckle, I would have spared myself and Utility Forecaster readers a great deal of pain. In fact, the UF Growth Portfolio would have vastly outperformed the utility averages as well as almost every major stock market sector, with the exception of real estate investment trusts.

That’s why my rule today is to sell any stock where the underlying business appears to be coming apart, even if overall market conditions are good and the shares are still at lofty levels.

Whether I’m talking about Canadian trusts, REITs or US utilities, I want to predict 20 of the next five dividend cuts; put another way, I’m always going to try to err on the side of caution, particularly when the overall market is weakening.

This approach has led to some unnecessary selling and bearishness.

And at least one of the weaklings I’ve been most negative on is being taken over at a good price--notably Peoples Energy by WPS Resources. But with so many stocks, funds, bonds and preferred shares to choose from--and the long-term capital gains tax rate at just 15 percent--there’s no excuse for getting sentimental about a particular stock. You only want to own businesses that are becoming more valuable, not those losing ground.

The second important lesson the Enron meltdown taught me is that insiders can conceal essential facts from virtually everyone until it’s too late. The story of how Wall Street analysts were shown around a fake trading room is well known now. Less appreciated is how Enron went bankrupt owing virtually every electric utility millions (if not billions) of dollars, but in perfect proportion to their size. In other words, no one was given enough exposure to bankrupt them, and so no one did sufficient digging until there was nothing left to do but write it off.

One of the things that sticks out in my mind from that era was a Bloomberg Forum on the power industry moderated by Lowell Miller, whose FLEX FUNDS TOTAL RETURN UTILITY (FLRUX) is the only broad-based, open-end utility stock fund I recommend. The conference featured speakers and attendees from all corners of the industry.

But the highlight was an appearance by Jeff Skilling, who was essentially Enron’s point man on Wall Street. The late Ken Lay, by contrast, was more on the country club back-slapping circuit.

Skilling swaggered into the room accompanied by a number of Enron employees and promptly told the utility executives in attendance that within five years his company would be doing 73 percent of their current business. What made the biggest impression on me was that these supposed competitors all seemed to be nodding their heads, almost without question.

Why were they so cowed? Because Wall Street was also saying they were toast unless they acted aggressively, from the credit raters who were downgrading traditional utility balance sheets to the stock analysts who projected virtually geometric earnings growth for Enron, presumably on the basis of numerous conversations and hundreds of hours of up-close research. In essence, despite Enron’s extremely high profile, its executives managed to conceal need-to-know information even from those paid rock-star salaries to look at companies skeptically. Given that, it’s impossible to expect individuals would have spotted the trouble.

As it turned out, only a handful of iconoclasts published skeptical opinions, and you can bet they didn’t have all the facts, either.

The only real defense anyone had was a very good nose, which I only developed after the stock had fallen to the low teens.

One way to protect against this kind of fraud is keep a careful eye on anything that’s losing ground in the stock market. If you can’t explain or readily find out why a stock or bond is falling dramatically, sell it. Note that I’m not endorsing a “sell first, ask questions later” approach. And sometimes stocks sell off and rebound for no discernible reason. But negative market action can be a pretty good early warning sign that something is fishy, and is at least worthy of a look.

The best way to protect yourself is simply to diversify your portfolio. The better balanced your portfolio is and the more its value is spread among several quality holdings, the less an unexpected disaster will hurt you. No one really saw how badly Enron’s crackup was going to bite in advance. But the hurt was a lot less for those who held the stock in a balanced portfolio than it was for those who held it as the bulk of their retirement accounts, as many former Enron employees did.

The third lesson from the fall of Enron is not to expect the government to make good on a fraud. Some Americans today look to Uncle Sam to do everything from providing them a comfortable retirement to regulating what children read. But even these true believers who lost with Enron haven’t recovered more than a smidgeon of what they’re rightfully owed. And no matter how hard judge and jury throw the book at Skilling or anyone else involved with the biggest corporate fraud in US history, that’s not going to change.

One reason is Enron had numerous friends in the high halls of government, and on both sides of the aisle. In my opinion, it did this for two reasons. The first was to get what it wanted from the federal government in terms of regulation and deregulation, which it did routinely in the ‘90s. Second, it was to create a massive group of co-conspirators that could be counted on never to really blow the whistle, for fear of self-incrimination. And thus far, despite the trumpeted trials of Lay and Skilling, we don’t know the half of what happened at that company or how so much wealth vanished so quickly.

The bottom line is when you invest no one but you is really looking out for your interests. Even companies run by honest, intelligent and well-meaning people can fail. And as the Enron wipeout proved, the woods are full of the other kind of folks.

The bottom line: Take care of yourself.