In praise of utilities? That is an intentional question mark, by the way. In more than seven years of writing columns for Real Money, I am not sure I have written a single one about the sector traders refer to affectionately as "the Utes."
My core investing strategy involves what I call "persistent reinvestment," but my selection of individual securities in which to create that virtuous cycle involves a calculus that has always, with only one or two exceptions in the past decade, left utilities out in the lurch.
There is a misperception that income investing is some kind of rejection of the search for growth, but that's not true at all. Every company I own has the ability to grow cash flows and support interest/dividend payments, often in the midst of a cyclical lull.
Growth is created not by Twitter memes but through prudent investment of capital. That's whether the utilities are hamstrung, as most of them are regulated. They can't go full-throttle to generate as much cash flow as possible and they are restricted in how much of their existing cash flow they can return to investors.
Bottom line: The Utes are too boring. Well, in the investment thunderstone that is 2020, the lack of opportunity for growth among utility companies may just be their biggest strength.
My analysis, as always, starts with earnings power. In this case the always useful Earnings Insight publication from John Butters at FactSet gave me a great nugget. Butters' June 12 Earnings Insight contained the following nuggets about the Utilities sector.
The Utilities sector has by far the highest number of companies that confirmed previous EPS guidance for 2020 (prior to the impact of COVID-19) during their earnings calls for Q1. Of the 40 S&P 500 companies that confirmed previous EPS guidance for 2020 during this time, 21 (53%) are in the Utilities sector. Given that there are only 28 companies in the Utilities sector, this means 75% of the companies in this sector confirmed previous EPS guidance issued for 2020 prior to the impact of COVID-19.
In terms of estimate revisions (on a per-share basis), the Utilities sector has recorded the smallest decline in CY 2020 EPS of all 11 sectors over the first five months of the year. The annual bottom-up EPS estimate (which is an aggregation of the median 2020 EPS estimates for all the companies in the sector) for the sector decreased by 1.6% from December 31 to May 31. This is the smallest decrease of all 11 sectors over this time frame. By comparison, the annual bottom-up EPS estimate for the entire S&P 500 fell by 28.1% during this period. In addition, the Utilities sector is projected to have the highest year-over-year earnings growth of all 11 sectors for 2020 at 2.4%.
So, in a world in which equity valuations are as detached from earnings power as I have seen them in 30 years of following stocks, utilities offer real value amongst the bubble-icious-ness of the S&P 500.
The best way to play the utilities?
Well, the worst way is to google "utility stocks" and buy the one with the highest dividend yield. That's how investors wind up in PG&E (PCG) situations.
A much smarter play is the Utilities Select Sector SPDR ETF. (XLU) sports an extremely attractive 3.31% yield versus the 1.90% yield for the S&P 500 and the 0.71% yield on the 10-year U.S. Treasury Note.
XLU is trading around $59 per share, down from its pre-crash high close of over $70 per share on Feb. 21. So, XLU has missed the recent equity market rally, but as FactSet's Butters points out, the "E" in its implied P/E has changed much less than that of the overall market's.
So, buy utilities here as a bond alternative and one of the few beacons of a value in a ridiculously overvalued stock market.