Thanks to a combination of low-interest rates and investors’ preference for higher-yielding defensive assets, the Utilities Select Sector SPDR (NYSEArca: XLU), the largest utilities sector ETF, has been a solid sector-level performer this year while currently offering an impressive dividend yield of almost 3%.
The utilities sector is one of this year’s best-performing groups, underscoring the notion that many investors will embrace utilities stocks and ETFs during favorable interest rate environments. The Federal Reserve recently obliged by lowering interest rates last week for the second time this year and another rate cut is possible before the end of this year.
While ETFs like XLU remain compelling for conservative, income-hungry investors, there’s a rising cost of admission involved with this popular low beta destination.
“Utilities are a sector that investors often turn toward for yield, but we also think that investors should be cognizant of valuations. Right now on the yield front, when you look at 10-year U.S. Treasuries below 2% and the U.S. dividend yield for utilities above 3%, utilities look like an attractive yield option. However, valuations are extremely rich,” according to Morningstar.
One Of The Year’s Best-Performing Groups
The utilities sector is one of this year’s best-performing groups, underscoring the notion that many investors will embrace utilities stocks and ETFs during favorable interest rate environments. Still, the sector looks pricey.
“Price/earnings multiples, price/book multiples are all well above three-year decade averages. Even we think the sector is well overvalued. Although it started the year at fairly valued, we think utilities are now 13% overvalued given the run that they’ve had in 2019,” said Morningstar.
Investors who are looking for companies to invest in that carry minimal risk will often consider utility stocks. Utility companies typically comprise the most fundamental necessities, such as food, water, and shelter, or are closely related to the energy required to refrigerate food, heat up water and light up a house.
There is some good news. While the utilities is, broadly speaking, looking pricey, some of XLU’s marquee holdings remain attractive.
“We do think there are some good yield opportunities. Industry has very good balance sheet strength, fair payout ratios, and a lot of good growth,” said Morningstar. “A couple of names we like are those yielding above 4%, such as CenterPoint, Duke Energy, Edison International, and Dominion Energy. We think these utilities are well-positioned to grow earnings and dividends based on the infrastructure investment needs across the U.S.”
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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.