Why Are My Utility Stocks Falling?

5/11/2015


Yield-loving utility investors may not love the suddenly higher dividend yields caused by the sector's recent slump. But it tends to be all or nothing for utility stocks. During the past six years, the S&P 1500 utility sector has produced the top calendar-year return among the index's 10 sectors twice — in 2014 and 2011. In the other four years, it finished either ninth or tenth. Utilities rank last so far in 2015, with the sector index posting a negative total return of 7.1%. By comparison, the broad S&P 1500 Index has returned 1.7%.

From a value standpoint, the sector looks pretty good. Utility stocks sport the lowest average trailing P/E and forward P/E ratios among S&P 1500 sectors. The stocks' average Quadrix Value rank of 66 trails only the 69 of the energy sector. Recent operating momentum lags most other sectors, as does estimated year-ahead profit growth. But utilities sometimes get leeway from the market when it comes to weak operating momentum.

The latest quarter is also shaping up fairly well. With 52% of S&P 1500 utilities having reported operating results, 71% have topped profit estimates, slightly above the broader index's 69% beat rate.

So why the poor share-price action?

Bond yields have jumped in recent days, with the 10-year Treasury bond yielding 2.23% as of May 6, up from 1.93% on April 24 and 1.68% at the end of January. With short-term rates held low since the 2008 financial crisis, income investors have had few ways to generate a decent yield. As a result, many moved into utilities and other high-yield stocks. Recent weakness in utilities and real estate investment trusts (REITs), both known for their high yields, suggest some investors are moving back into bonds.

Last year, Morningstar studied how dividend stocks performed in different interest-rate environments from July 1927 through the end of 2013. It found that stocks with the highest dividend yields outperformed other stocks in periods when interest rates held flat or decreased. But high-yield stocks severely lagged peers when interest rates rose, while non-dividend stocks performed best.

Not surprisingly, the criterion Morningstar used to define high-yield stocks — yields in the top 30% — applies to utilities. Utilities in the S&P 1500 average yields of 3.5%, more than twice the average of 1.6% for all index stocks, and all 60 utilities qualify for the top 30%.

So what's an investor to do? Consider why you bought utility stocks in the first place. If your goal centered on diversifying a broader portfolio or gaining a steady stream of income, then utilities still have merit. If you were trying to chase the returns of recent winners, then you might want to consider other options.


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