Electric Utility Stocks Are Not Safe Right Now

by Tim Melvin | August 28, 2013 7:45 am

Looking back over more than 25 years as portfolio manager, columnist and broker, I can honestly say that I have never lost a dime in electric utility stocks.

Yes, I have owned dozens of them at various times in my career and made money every single time.

There were two secrets to my successful approach. First, I waited for a market collapse or economic slowdown to be a buyer of electric utility stocks. I always purchased them at a discount to tangible book value without worrying about earnings or even dividends.

The power plants, transmission lines and other facilities owned by utilities are extraordinarily valuable and buying them at a discount to book creates an enormous margin of safety.

The second secret to my success with utility stocks is that I held them until a recovery occurred. Markets will get better with time and the economy usually rights itself as soon as the politicians quit trying to fix it. As the sector begins to improve, I usually start selling the stocks at somewhere between 1.5 and 2 times book value.

My average holding period has been about 2.5 years and, if you ask me, doubling my money plus collecting decent dividends along the way is a pretty successful investing approach.

When I look at the electric utility sector right now, though, not one single stocks trades at a discount to book value. Yield-seeking investors have been steadily buying the shares and pushing them up to what I think are unsustainable valuation levels.

In spite of this, Wall Street analysts continue to recommend the stocks — especially for income seeking investors — and I think it could turn out to be very painful to take their advice right now. Utility stocks trading at more than 2 times book and 20 times earnings are in a danger zone … and that is exactly where many of them trade right now.

If you look at a price chart of an electric utility stock, most of them look like growth stock issues over the past year — moving up at a rapid pace. Many of them are up 30% to 40% or more in the past year.

But business conditions haven’t improved for the utility sector in a way that justifies such a run.

Instead, it’s all about yield-chasing and low interest rates. Sadly, investors who buy here in hopes of collecting dividends may just find that the 4% dividend does little to offset the double digit loss they experience in power paying for the shares.

The bottom line: Electric utility stocks have long been considered a safe haven for investors, but right now they are anything but that.

Avoid the sector until the stocks become more reasonably priced.

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