Warren Buffett once said, “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.” I fully agree.
Trending economic condition
The rebounding housing market and rising Dow Jones are wreaking havoc within the utility sector. Traditionally known as safe, dividend paying investments, utility stocks are now being sold like hotcakes.
Why?
One major reason is because of the increase in bond yields, which provide another competitive option for income. Another explanation could be the influx of capital into high growth sectors like technology or industrials. As a result, though, new opportunities are looming.
Behind the scenes glance
As seen below, the Utilities Select SectorSPDR ETF is the largest ETF connected to utility stocks.
| Utilities Select Sector Top Holdings | Percent of Assets |
|---|---|
| Duke Energy Corp (NYSE:DUK) | 9.64% |
| The Southern Company (NYSE:SO) | 8.33% |
| Dominion Resources, Inc. (NYSE:D) | 6.85% |
| NextEra Energy, Inc. (NYSE:NEE) | 6.73% |
| Summation of Top Four | 31.55% |
It is undergoing a major market beating. Over 31% of the ETF endured an 8% price decline just in the past month. It is improbable to think that 70% of the other stocks in the ETF—especially since they are in the same sector—could counter balance the decrease. For short term traders, this fund is abysmal. But for those with longer time horizons, a gold mine exists.
| Utilities Select Sector | Southern Company | Duke Energy | Dominion Resources | NextEra Energy | |
|---|---|---|---|---|---|
| May 13′ Decline | 8.14% | 8.24% | 10.63% | 7.51% | 7.02% |
| Beta | 0.09 | 0.17 | 0.25 | 0.38 | |
| Dividend Yield | 4.50% | 4.40% | 3.90% | 3.40% |
With an infinitesimal beta and a market cap of almost $40 billion, The Southern Company (NYSE:SO) is here to stay. As further proof, the firm recently increased its quarterly dividend payment. Southern has never missed a dividend payment to its shareholders since its founding in 1948.
Additionally, it is trading at a discount. As of the most recent quarter, just Southern’s property, plant, and equipment will pay down all liabilities by 112%. Further, the firm’s year over year quarterly revenue growth rate is 8.1% and its operating margin TTM is almost 24%. Further analysis reveals that it is almost nearing its year low support level. The firm is a good buy.
Duke Energy Corp (NYSE:DUK) is the largest electric power company in America, and it continues to prosper. Assuming its expected $2.1 billion TTM will be met in 2013, Duke’s net income will increase nearly 60% since 2010. Further, the firm’s high dividend yield and low beta make it even more attractive.
As evidenced by the graph below, I anticipate that Duke Energy Corp (NYSE:DUK) will not drop below its 1 year support level of $60. Buying long and even shorting are both reasonable moves.
Dominion Resources, Inc. (NYSE:D) and NextEra Energy, Inc. (NYSE:NEE) will also benefit from the recent decline. PJM Interconnection’s annual report sheds light into electricity pricing and supply increasing within particular markets. The negative effects of the PJM pricing models are expected to hamper the Northern utility market. However, due to their regions of operations, Dominion Resources, Inc. (NYSE:D) and NextEra should not be affected.
Like other utilities, both firms also boast low betas and high dividend yields. For context, the S&P 500 only has a yield of about 2.2%. NextEra and Dominion Resources, Inc. (NYSE:D) are also poised for further growth. NextEra’s forward P/E ratio is nearly 15 and Dominion’s is about 16. Unlike Southern and Duke Energy Corp (NYSE:DUK), both firms are still above their 2013 lows. Therefore, they could still decline. Shorting and then hedging may be your best move.
What Warren would do
Even if the Fed trims its bond-buying program and bonds become more competitive, I anticipate that the Utilities Select Sector ETF will increase along with the utility sector. But, in the meantime, utility stocks will provide you with a hefty dividend and future growth. Just be sure to thank those who sold their shares to move the market. Mr. Buffett would.
Brendan Marasco has no position in any stocks mentioned. The Motley Fool recommends Dominion Resources and Southern Company.
The article Effects of Recovery Highlight These Utility Goldmines originally appeared on Fool.com.
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