Searching For Value In Utilities

8/11/2014


So far this year, the S&P 1500 Utility Sector Index has returned 8% including dividends, well above the broader index's 5% and third-highest among the 10 market sectors.

While utilities typically don't lead in up markets, the last decade has been kind, with the sector index managing a 10% annualized return while the broader S&P 1500 delivered an 8% return.

After such a strong decade, nobody would be surprised if utility stocks looked somewhat expensive relative to their history. However, while utilities tend to trade at a premium to their five-year average valuation ratios, so do stocks from most other sectors. In fact, utility premiums are roughly in line with the index average.

As a group, utilities still boast the highest average Quadrix Value score (71) of any S&P 1500 sector. Credit their lower absolute valuation ratios.

Utilities' average price/earnings ratio of 16 and price/book ratio of 1.7 are the lowest of any sector, while their price/sales ratio of 1.6 is well below the index average.

With the average utility in the S&P 1500 trading at a 2% premium to its five-year average P/E ratio, 16% above its five-year average P/S, and 9% above its five-year average P/B, it is no surprise that most industry groups in the sector look pricey relative to history. The exception is natural-gas utilities, which average a 9% discount to the five-year average price/earnings ratio and price/book ratios 4% below historical norms.


Utilities cheap versus other sectors

The utility sector averages lower price/earnings, price/sales, and price/book ratios than the average stock in the S&P 1500. Utilities look less cheap relative to historical norms and their profit-growth potential. Price/earnings-to-growth (PEG) divides the P/E on estimated year-ahead profits by the long-term growth estimate.

Among the stocks in our Utility Update, electric utilities earn the highest average Quadrix Value scores. Gas utilities also look cheap, with among the lowest absolute valuations and favorable comparisons to historical norms.

Price/Earnings
------ Ratio ------
Price/
Earnings-
To-Growth
(PEG)
Price/Sales
------ Ratio ------
Price/Book
------ Ratio ------
S&P 1500 Sector
Quadrix
Value
Score
Trailing
Vs. 5-
Yr. Avg.
Trailing
Vs. 5-
Yr. Avg.
Trailing
Vs. 5-
Yr. Avg.
Utilities
71
16
1.02
3.0
1.6
1.16
1.7
1.09
Cons. discretionary
62
20
1.11
1.3
1.5
1.15
2.1
1.24
Consumer staples
54
22
1.16
1.9
1.8
1.18
3.5
1.18
Energy
64
22
1.07
1.4
2.4
1.01
2.1
1.05
Financials
59
22
1.00
1.8
4.0
1.22
2.0
1.11
Health care
46
25
1.18
1.6
3.0
1.21
3.9
1.21
Industrials
61
20
1.04
1.4
1.5
1.17
2.4
1.14
Materials
58
22
1.09
1.7
1.5
1.15
2.6
1.13
Technology
54
22
0.94
1.4
2.9
1.10
3.1
1.05
Telecom
58
30
1.34
2.7
1.7
1.12
4.2
1.39
S&P 1500 Index
58
22
1.06
1.6
2.4
1.16
2.6
1.13
Stocks in our Utility Update by industry
Electric 
76
16
1.03
3.1
1.6
1.15
1.6
1.08
Natural gas
72
16
0.91
3.0
1.3
1.09
1.8
0.96
Water
56
21
1.00
2.6
3.0
1.11
1.9
1.02
Util./energy hybrid
53
24
1.10
2.8
4.0
1.12
2.7
1.11
Diversified
68
17
1.04
2.8
1.4
1.22
1.9
1.14
Notes: Quadrix scores are percentile ranks, with 100 the best.    Valuation ratio averages exclude some outliers.

Two years ago, utilities averaged Quadrix Value scores of 43 and Overall scores of 42, reflecting their unappealing valuations and weak fundamentals. But today the sector looks a lot better by the numbers. We added UGI ($48; UGI) to the Long-Term Buy List in February and the Buy List in March. See page 5 for a brief review of UGI.

Investors who'd like to hold more than 5% of their equity portfolio in utilities should consider our Top 15 Utilities Portfolio, shown at www.DowTheory.com/go/Top15 and in Other Selections. We advise readers to purchase equal-dollar amounts of all 15 utilities; the resulting portfolio yields slightly more than the average utility, with superior growth potential.

Since its inception in 2007, the Top 15 Utilities Portfolio has returned 105.2% including dividends, versus 55.4% for the S&P 1500 Utility Sector Index.


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