With Utilities, Value Works Best
11/11/2013
Of the six category scores used to calculate our Quadrix Overall score, Value has been the most effective.
Stocks in the top quintile (onefifth) as measured by Value score have outperformed high scorers in the other five categories in eight of the 10 sectors Standard & Poor's uses to segment the stock market. In the other two, Value has been secondbest. The Value score has been particularly effective with utility stocks.
The Overall score has not worked very well with utility stocks. Neither have most of the category scores. But Value stands out, with top scorers outperforming the average utility stock by an average of 2% in rolling 12month periods since October 1994.
Even within the Value score, which is derived from more than a dozen valuation metrics, some individual statistics work better than others. We've isolated four valuation ratios (price/sales, price/book, price/cash flow, and enterprise value/EBITDA) that satisfy the following criteria:
• Comprehensive coverage. More than 95% of utility stocks in the S&P 1500 Index generate a score for these metrics. For example, while valuation ratios relative to free cash flow tend to have predictive power with utilities, most utility companies don't provide enough data to calculate a price/free cash flow ratio.
• Long history. We have data for all four ratios dating back 19 years. Some valuation metrics based on earnings estimates showed promise, but we disregarded them because our estimates data only reaches back to 2004.
• Strong performance. As measured by each of the four ratios, the top onefifth of S&P 1500 utility stocks outperformed the average stock by an average of at least 2% in 12month periods over the last 19 years.
Within the sector, electric utilities — which comprise 40% of the companies in the sector and more than 50% of its stockmarket capitalization — average the highest Value scores (74) of any industry group, as well as slightly higher scores in the four key ratios. While utilities as a group look attractively valued, water utilities continue to stand out from the crowd as far more expensive than the rest.
Compared to the average utility in the S&P 1500, stocks in our Top 15 Utilities portfolio average higher scores for Overall, Value, and all four of the powerhouse valuation ratios.
