Will Utilities Stay Strong?
Over the last three, five, and 10 years, utility stocks have outperformed the broad market.
Does that mean that utilities have suddenly begun generating outsized profit growth, or that they are likely to pace the market over the next decade?
Not exactly. Utilities’ profits are less sensitive to the economy than those of most companies, and such defensive stocks tend to hold up better than most during economic downturns. Since 2007, the S&P 1500 Utility Sector Index delivered a negative total return of 5.7%, versus a negative return of 9.8% for the broader index.
On average, utility stocks look better now than they have over most of the last five years. Historically, our Quadrix® rating system has not favored utilities, with scores dragged down by weak growth and high debt levels.
But, as the table below illustrates, the average utility stock in the S&P 1500 Index earns a Quadrix Overall score of 58 and a Value score of 80. The average utility trades at 15 times trailing earnings and at a discount of 8% to its five-year median P/E ratio.
While the utility sector enjoys stronger fundamentals than was common in the past, investors should remember that they are still utilities, labeled as defensive for good reason. If the market trends higher over the next five years, history suggests utility stocks will lag. From December 1991 through Feb. 26, the broad Dow Jones U.S. Index delivered an annualized return of 7.8%, versus 6.5% for the utility sector index.
No, utilities are not likely to pace the market, particularly if it rises in coming years. But as long as investors do not expect outsize returns, utility stocks offer some benefits.
Yield: The average S&P 1500 Index utility yields 4.2%, versus 1.3% for the average stock in the index. Income-oriented investors tend to like utilities, although they should not make up more than 15% to 20% of a portfolio.
Low volatility: Among stocks in our universe with 10 years of history, the median utility is less than half as volatile as the median stock, as measured by standard deviation. Standard deviation reflects how widely monthly returns deviate from the average return.
Diversification: The utility sector index has a lower correlation with the broader index than any sector index other than consumer staples.
If utilities appeal to you, we have a suggestion. Check out our Top 15 Utilities portfolio, presented in the table below. This week, we made two changes to the portfolio.
The Top 15 portfolio is designed to provide a yield comparable to that of the average utility along with substantially higher growth potential. Excluding dividends, the Top 15 portfolio has outperformed the S&P 1500 Utility Sector Index by more than 12 percentage points since its inception in 2007.