Utilities Safer In Numbers
So far, 2009 has not been friendly to utilities. As of May 5, the S&P 1500 Utility Sector Index was down 8%, and the average stock in our Utility Update had declined 9%.
For decades, utilities were considered defensive stalwarts, companies with fairly steady profits and fat dividends capable of supporting the stocks in difficult times.
However, a quick look at market returns will show you that times have changed. Since the market peak in Oct. 2007, the S&P 1500 Utility Sector Index has fallen 34% — nearly as bad as the broader S&P 1500 Index.
Utilities tend to be heavily leveraged and have only modest growth potential — a combination that does not inspire confidence in a market plagued by credit worries. Massive dividend cuts also have income-oriented investors spooked, despite the fact that utilities’ payouts have held up fairly well.
While utilities appear to have fallen out of favor, the Forecasts still sees some value in the sector. However, utilities tend to score poorly in our Quadrix® stock-rating system — in large part because of their low growth and high debt — and we tend to favor stocks with greater capital-gains potential. We currently recommend just two utility stocks as Long-Term Buys, and neither is a traditional utility company.
Still, we understand that many subscribers wish to own utilities for their dividends. For such investors, we have selected a handful of utilities to form a diversified portfolio with a solid 4.3% yield and growth potential higher than that of the average utility. Check out the Top 15 Utilities portfolio in the table below. Since its inception in 2007, the Top 15 Utilities portfolio has outperformed the S&P 1500 Utilities Sector Index by nearly five percentage points.
If you only want to own one or two utility stocks, Energen ($35; EGN) and Questar ($33; STR) represent our top selections in the group. Both operate regulated natural-gas utilities as well as large energy-production businesses. They don’t pay the high yields many expect from utilities, but neither are they heavily leveraged — and energy operations give both companies better long-term growth potential than most traditional utility companies.
If instead you want to put a meaningful portion of your portfolio in utilities, then consider the Top 15 Utilities portfolio. All of the stocks in the portfolio earn A ratings in our Utility Update. While most of the 15 don’t have the mix of growth and value we require to earn a Buy or Long-Term Buy rating, all make sense as a small part of a diversified portfolio.
We are adding two new stocks to the Top 15 Utilities portfolio: FirstEnergy ($42; FE), a provider of electricity to 4.5 million customers, mostly in Ohio, Pennsylvania, and New Jersey; and ONEOK ($27; OKE), a diversified natural-gas company that operates regulated natural-gas utilities and gathers, transports, and markets gas. The new stocks will replace laggards American Electric Power ($27; AEP) and Pepco Holdings ($13; POM), both of which have seen growth slow and Quadrix scores deteriorate in recent months. Pepco was expected to release earnings May 7, after the Forecasts went to press. While the stock seemed capable of a near-term rally on good results, a better-than-expected report would not be enough to keep us in the stock.