Utilities are the classic “widow-and-orphan” stocks—meaning they are slow and steady providers of dependable income. Lately, these stocks have been anything but slow and steady. Many stocks in the sector have enjoyed huge run-ups in price over the last few years and are now sitting near multi-year highs.
Not to rain on the parade, but it’s worth noting that there is a price to be paid for such dependability, and that is extremely modest growth. Utilities just can’t provide significant growth, even in a booming economy, purely as an inevitability of their business models.
As a result, many of the biggest publicly-traded utilities in the United States now trade for earnings multiples that exceed the same multiples of the S&P 500 Index. Moreover, the dividend yields on utility stocks have moved downward in conjunction with their rallying share prices (since prices and yields are inversely related).
Investors need to decide how much they’re willing to pay for little growth potential and dividend yields that aren’t anything to brag about.
Expanding multiples, declining yields
The SPDR Utilities fund holds many of the biggest publicly-traded utilities, and yields 3.7% as a whole. Moreover, the fund’s components have an average price-to-earnings ratio of more than 16 times, which is close to where the broader market trades.
More striking is that many of the fund’s biggest holdings trade even more expensively than the fund. The fund’s top two holdings, Duke Energy Corp (NYSE:DUK) and The Southern Company (NYSE:SO), trade for 21 and 19 times trailing twelve-month earnings per share.
These kinds of valuation multiples for utility stocks have to raise the eyebrows of disciplined value investors.
Ditto for Consolidated Edison, Inc. (NYSE:ED), which trades for a trailing P/E of 17. This is a fairly lofty level when you consider that the company reported $3.75 in earnings from ongoing operations in 2012 and expects 2013 results to be between $3.65 per share and $3.85 per share. That means that the average of the range would represent no growth year over year.
It’s true that Consolidated Edison, Inc. (NYSE:ED) raised its dividend for the 39th consecutive year, which is a remarkable streak that the company and its investors should be proud of. But it should be noted that the dividend was raised by a scant 1.6%–indicative of the lack of growth potential utilities really have.
Dependable income, but at what cost?
Of course, it goes without saying that investors who buy utility stocks do so by and large because of the safe yield. Utilities provide electricity, and are therefore critical to the prosperity and security of the nation. Even in a dire economy, utilities provide investors the certainty of reliable earnings and dividends.