While smaller stocks and higher-beta market segments have regained their footing in February, the first month of the year brought a revival in defensive sectors with lower exposure to the turmoil in the emerging markets. Volatility certainly could return at any time — especially with stocks having come so far, so quickly, in the past week — but betting against this bull market is a tricky proposition until proven otherwise.
Fundamentals, Valuations Don’t Make the Case
Utility stocks could lose one or more of these pillars of recent support and keep chugging along if the fundamental story were intact. For the overall sector, however, the profile of growth and valuation isn’t particularly compelling. According to FactSet, utilities are expected to deliver revenue growth of 2.2% in 2014, behind the 3.7% estimated for the S&P 500 and ninth out of ten sectors (only energy is worse). Bottom-line earnings are expected to rise just 3.1%, last among all sectors and well below the 9.4% of the S&P.
Worse, the estimates for utility stocks are falling faster than those of the broader market. Estimated revenue and earnings growth for utilities have fallen 15.4% and 20.5%, respectively, since December 31, versus 7.5% and 11.3% for the S&P 500.
Despite this, FactSet reports that utilities are trading at a premium multiple to forward earnings (15.1x) versus both the S&P (14.6x) and the sector’s own 10-year average (14.0x).
That’s a steep price to pay for below-average growth and prices that have been propelled by trends that may not last much longer.
|American Electric Power||AEP||5.9%|
|Public Service Enterprise Group||PEG||7.4%|
Utility stocks still provide the largest dividend yield of any sector in the market, and in that sense they remain a compelling play for longer-term, income-oriented investors. For now, however, there’s no need to rush into this sector — the market will almost certainly provide patient investors with a more favorable entry point before long.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.