The Appeal Of Utilities

9/26/2011


The Forecasts prefers stocks with both attractive valuations and solid growth potential. As a sector, utilities offer neither. Yet market action suggests investors can’t get enough utility shares.

Utilities in the S&P 1500 Index have averaged an 11.8% total return so far this year, by far the highest of any sector. Utilities have also averaged 1.9% returns over the last three months, the only sector to notch positive returns in that period. The utility index nearly matched a three-year high on Sept. 20, and four of the stocks in our Top 15 Utilities portfolio hit new highs for the year on that day. 

The metrics we traditionally use to consider stocks don’t cast utilities in a good light. The S&P 1500 Utility Sector Index’s trailing price/earnings ratio of 14.7 is in the middle of the pack among market sectors, well above the valuation of the financial, energy, and health-care sectors. Consensus estimates project the utility index’s per-share profits will rise just 3% this year and fall marginally in 2012.

TOP 15 UTILITIES PORTFOLIO
The Top 15 Utilities portfolio is designed to deliver a yield comparable to that of the average utility, along with superior capital-gains potential. Since the start of 2007, the portfolio has returned 31.8%, more than twice the utility sector index’s 15.5% total return. Quadrix scores are percentile ranks, with 100 the best.
Trailing
P/E
Ratio
Vs.
Sector
Avg.
Quadrix
Scores
Company (Price; Ticker)
Div.
($)
Yield
(%)
Value
Overall
Industry
AGL Resources
($41; AGL)
1.80
4.4
13
0.82
49
47
Gas
Alliant Energy
($40; LNT)
1.70
4.2
13
0.83
54
74
Electric
Amer. Electric Pwr.
($38; AEP)
1.84
4.8
12
0.76
60
66
Electric
Cleco ($35; CNL)
1.12
3.2
16
1.00
49
68
Diversified
CMS Energy
($20; CMS)
0.84
4.1
14
0.84
57
70
Diversified
Duke Energy
($20; DUK)
1.00
5.1
14
0.84
57
55
Electric
Energen ($45; EGN)
0.54
1.2
11
0.70
65
55
Hybrid
Entergy ($66; ETR)
3.32
5.0
9
0.57
84
65
Electric
Exelon ($44; EXC)
2.10
4.8
10
0.63
70
76
Diversified
Laclede Group
($38; LG)
1.62
4.2
13
0.82
63
80
Diversified
NextEra Energy
($56; NEE)
2.20
4.0
13
0.78
60
43
Electric
PPL ($29; PPL)
1.40
4.8
10
0.63
68
77
Diversified
Public Service Ent.
($35; PEG)
1.37
3.9
11
0.69
63
70
Diversified
Sempra Energy
($53; SRE)
1.92
3.6
13
0.77
58
61
Diversified
UniSource Energy
($38; UNS)
1.68
4.5
13
0.81
59
50
Electric
Portfolio average
4.1
12
0.77
61
64
Average for 81 stocks
in Utility Update
3.7
16
0.99
47
46

Utilities tend to earn mediocre Quadrix® scores, hurt by weak operating momentum and high debt levels. The 81 stocks in our Utility Update average Overall scores of 46, with not one above 80.

Still, utility stocks have appeal for income-oriented or risk-averse investors. We recommend that instead of purchasing just one or two utility stocks, subscribers opt for equal-dollar positions in our Top 15 Utilities, listed above. This week we are adding two new stocks to the portfolio — Missouri gas utility Laclede Group ($38; LG) and Sempra Energy ($53; SRE), an electricity and gas provider in Southern California. These additions replace Avista ($25; AVA) and DTE Energy ($51; DTE), both of which have suffered slowdowns in growth.

Here are three reasons to consider utilities:

Risk/return profile. Over the last 16 years, the utility sector index averaged a total return of 9.1%, slightly above the broader S&P 1500 Index’s 8.7%. Yet the utility index’s returns were also less volatile.

Valuation relative to bond yields. The S&P 1500 utility sector’s earnings yield — the inverse of the P/E ratio — is 6.8%, slightly above the average of 6.0% since 1996. However, the current earnings yield is nearly five percentage points higher than the yield of the 10-year Treasury bond. The average utility’s dividend yield is also nearly twice that of the 10-year Treasury bond, though the bonds have historically averaged higher yields than utility stocks.

Business stability. Because utilities generate most of their revenue from regulated monopolies, they are less susceptible to economic downturns. This fact contributes to the stocks’ relatively low volatility.


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