Valuation of Utility Stocks

As interest rates rose this week, utility stocks (which normally trade in the same direction of bond prices) also got hit hard.

Utilities had been strong performers over the last decade, but have struggled over the last year as investors have favored higher beta, lower quality names. In addition, utilities have suffered from lackluster demand in the current weak economic environment.

I think that utilities can make a lot of sense in here for longer term investors that need dividend. Bernstein analyst Hugh Wynne also agrees. Here's few key points, with the full link to Hugh's 23 page research report below.

Highlights

• Regulated utilities today appear conservatively valued, based not only on the traditional valuation metrics of dividend yield and price to earnings, but also on two of our three favored quantitative measures of relative valuation: the dividend yield and earnings yield of utility stocks relative to the ten year U.S. Treasury yield.

• Relative to the S&P 500, the average dividend yield and P/E multiple of regulated utility stocks are at some of the most attractive levels of recent years.

• Regulated utility stocks today yield 4.8%, on average, while the dividend yield of the S&P 500 is1.8%. The ratio of utility dividend yields to that of the S&P 500 is thus 2.7x, the highest since 2003.
• While the S&P 500 currently trades at 15.0x 2010 estimated earnings, regulated utilities trade at12.8x, a discount of 14% and one of the lowest relative forward P/E multiples vs. the S&P 500 of the last five years.

• Utilities also appear conservatively valued on two of our three favored quantitative measures of relative valuation:

• The historical relationship between Treasury bond yields and utility earnings yields indicates regulated utility stocks are 9% undervalued. The difference between regulated utilities' current earnings yield of 7.8% and our model's predicted value of 7.1% is nearly one standard deviation from the historical mean.
• The historical relationship between after-tax Treasury bond yields and after-tax utility dividend yields indicates regulated utility stocks are 30% undervalued.
  

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