The utilities sector is often richly valued relative to the broader market due to its low beta posture and reputation for above-average dividends. The sector is also seen as a fixed income substitute. Two of those three factors — high dividends being the exception — would appear to work against those stocks this year, but the sector isn’t as expensive as it usually is, indicating that it could be worth examining exchange traded funds such as the Invesco S&P 500 Equal Weight Utilities ETF (RYU).
“Utilities’ great revaluation might finally be here. After the sector’s 14% drop since mid-September, we think utilities offer a compelling investment opportunity,” according to Morningstar. “Valuations recently reached levels that are as attractive as they have been in nearly 15 years, excluding the brief COVID-19-induced crash in 2020. In mid-October, utilities traded at an 11% discount to our median fair value estimate, the largest discount since the COVID-19 crash and the 2008-09 recession.”
RYU is strutting its stuff this year. The Invesco fund participated in the November 10 market surge, jumping 4.79%, putting it in the green on a year-to-date basis. Although that took more than 10 months, give credit where it’s due because RYU has been thumping the broader market this year. Plus, the dividend story in the sector remains intact.
“Utilities’ dividend yields are back near 4%, their long-term average. Balance sheets are as strong as they’ve been in 50 years, and growth opportunities abound,” added Morningstar. “Many high-quality utilities that hit peak valuations six months ago now trade at prices that we think offer investors attractive long-term risk-adjusted returns. We see several good buying opportunities, but we also think there are some warning signs that investors should not ignore.”
Speaking of payouts, RYU yields 3.56%, or 61 basis points above the largest cap-weighted utilities ETF. Plus, RYU is beating cap-weighted utility ETFs, many of which are in the red this year. All that at some attractive multiples.
“Utilities’ average price/earnings ratio also has come down as stock prices fall and earnings grow. In April, the Morningstar US Utilities Sector Index topped a 24 P/E, a record high in at least 25 years and a 6-point premium to the Morningstar US Market Index’s P/E. Utilities are approaching their historical average 17 P/E and offer little premium to the market,” concluded Morningstar.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.