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.
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.
I’ve written favorably about utilities in the past, but things have changed dramatically since then. For example, Southern Company recently traded for $48 per share, representing a 12% return just since the beginning of the year. Duke Energy Corp (NYSE:DUK), meanwhile, rallied 13% from the beginning of 2013 to over $75 per share before giving back a couple dollars per share.
Both these stocks were yielding 4.5% just a couple months ago, but due to such dramatic gains in such a short period of time, new investors are getting 70 basis points less in yield than they could have gotten so recently.
At this point, it doesn’t seem prudent to pay 20 times earnings for a little-to-no growth stock with a yield below 4%. A few years ago, utilities were trading for much more reasonable valuations and yielded 5% or more. If those conditions existed today, I would view utilities in a much better light. But those days are behind us, and at least for the time being, utilities just don’t offer a nearly compelling enough opportunity.
The article This Sector Looks Fully Valued originally appeared on Fool.com and is written by Robert Ciura.
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