Utilities Look Better, But Don't Overdo It

3/31/2014


We write about utilities at least eight times a year, and by now you've probably read the reasons why we don't usually talk them up.

Low growth, subpar returns, and weak fundamentals are our chief complaints, but nowadays only one of those complaints is justified.

As the table below shows, utility stocks stack up pretty well against other sectors:

Returns. Utilities in the S&P 1500 Index enjoy strong share-price momentum, averaging three-month total returns (including dividends) of 6%, tops among the 10 market sectors.

Fundamentals. Average Quadrix Overall scores of 60 and Value scores of 69 rank utilities third and first, respectively, among sectors in the S&P 1500.

Valuation. The sector's average price/earnings ratio of 18 is by far the lowest in the S&P 1500. Utilities also look attractive based on price/book and price/cash flow ratios, not to mention the Value score.

UTILITIES COMPARE WELL
In our row of ranks, No. 1 is the best (highest for yield, returns, growth, and Quadrix scores, and lowest for valuation ratios like P/E). As usual, utilities' average profit-growth potential lags the market. But high Value and Overall scores and attractive valuations provide reasons for optimism about some utility stocks.
-- P/E Ratio --
12-Month
- Growth -
Estimated
-- EPS Growth --
Quadrix
----- Scores -----
Sector
Yield
(%)
3-Mo.
Total
Return
(%)
Trailing
Vs. 5-
Yr. Avg.
Sales
(%)
EPS
(%)
Curr.
Year
(%)
Next
5 Yrs.
(Annual.)
(%)
Value
Overall
Cons. Discretionary
1.1
(2)
21
1.19
8
9
9
15
58
62
Consumer
Staples
1.8
4
23
1.24
5
10
12
11
55
58
Energy
1.0
5
22
1.23
9
3
15
15
67
60
Financials
2.5
2
22
1.07
8
13
8
9
58
60
Health Care
0.6
2
25
1.21
8
5
9
15
47
55
Industrials
1.2
1
22
1.13
6
9
11
13
59
63
Materials
1.4
4
24
1.20
4
4
13
13
58
57
Technology
0.7
4
24
1.05
5
4
11
14
51
58
Telecom
3.9
0
25
0.95
1
(5)
9
8
68
51
Utilities
3.5
6
18
1.17
8
2
4
5
69
60
Utilities rank
among sectors
2
1
1
5
5
9
10
10
1
3
S&P 1500 average
1.4
2
23
1.14
7
7
10
13
57
60
Notes: All numbers are averages and exclude some outliers.   Quadrix scores are percentile ranks, with 100 the best.

The growth picture remains unappealing, with utilities averaging per-share-profit growth of just 2% over the last year (second worst). And they have the lowest expected profit growth over the next one and five years. Still, as a whole, the sector looks better than it has during most of the past two decades. For statistics and ratings (A for above average, B for average, C for below average) on nearly 80 stocks, check out our Utility Update.

At the moment, we recommend one utility — UGI ($45; UGI) — as a Buy and a Long-Term Buy. However, investors who wish to sink more than 5% to 10% of their portfolio into utilities should broaden their sights and try our Top 15 Utilities portfolio (www.DowTheory.com/Go/Top15).

Our focus on high-quality, high-growth utilities has yielded benchmark-beating returns in six consecutive calendar years. Since its inception in 2007, the Top 15 Utilities portfolio has returned 104.5%, well above the sector index's 54.8%. The Top 15 has returned 5.8% so far this year, slightly lagging the sector index's 7.6%.

Investors seeking utility exposure should consider purchasing equal dollar amounts of the 15 stocks in our portfolio. But we'll stop short of advising you to stuff your portfolio with utilities because there's downside news on all these fronts.

Returns. In 12 of the last 19 years, utilities have ended up in the bottom half for total returns among sector indexes, including nine years among the bottom three. While past returns are lousy at projecting returns over the next year, the fact that utilities have tended to lag other sectors over time — frequently delivering extremely low returns — is worth remembering. History warns against expecting too much from a sector that has consistently delivered profit growth well below the market average. Of course, utilities, regulated providers of essential services, have over the last 15 years historically delivered less-volatile monthly returns than all but the consumer-staples and health-care sectors. Many investors are willing to accept lower returns because of the reduced risk.

Fundamentals. Since 1994, utility stocks in the S&P 1500 have averaged Overall scores of 53, below the index average of 58 and ninth among sectors. Blame weak growth and mediocre balance sheets for the low Overall scores. While utilities look decent now, history suggests they won't always.

Valuation. Don't discount the high Value scores, they're legitimate, and roughly in line with the sector's long-run average. But utilities aren't particularly cheap relative to their own historical norms. On average, S&P 1500 utilities trade at a 17% premium to their five-year average price/earnings ratio, fifth-lowest out of the 10 sectors but slightly above the average for the broader index.


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