Dividend Yields Signal Reversion to Boring for Utilities

Utilities aren’t supposed to be exciting, either as a business or an investment.

They provide you with heat and power and you grumble when the bill is too high. As an investment, they pay you a handsome dividend and you agree not to grumble when the share-price returns are low.

That’s always been the deal -- they’re boring but reliable. Sort of like the Ted Koppel of stocks. This year has marked a startling shift in which utilities in the S&P 500 have surged 13 percent, more than double the next biggest gain among the 10 main industry groups. It’s as if Ted Koppel suddenly ripped off his shirt and smashed a double-neck guitar right there on the anchor desk.

For sure, there were some valid reasons for the excitement. With quarterly results out for 25 of the 30 utilities in the S&P 500, the group has posted earnings-per-share growth of 21 percent and has beaten the average of analysts’ estimates by almost 9 percent. That puts them in contention for the highest earnings growth, and biggest positive surprise, of the 10 main industries.

Yet much of the growth in profit can be chalked up to what may or may not be a one-time event: the harshest North American winter in three decades. In other words, “favorable weather” for companies selling heat and power, as Dominion Resources Inc. referred to it in its April 30 earnings release. (It was not so favorable for other industries that rely on consumers actually leaving the house.)

Past, Future

The sharp growth in profits means the group’s valuations don’t appear overly stretched. At 16.3 times reported earnings, utilities still trade at a discount to the S&P 500 while above their own 10-year average of about 14.8.

Yet, looking ahead, they are more expensive than the S&P 500 based on projected earnings over the next 12 months. They are also one of only three groups that are more expensive when looking at their own forward earnings projections compared with reported results. Financials and consumer-discretionary stocks, this year’s worst-performing groups, are the other two.

The rally in the shares is also making their payouts from dividends less attractive. At 3.6 percent, the group’s yield is the lowest since 2008. They’re paying about 1 percentage point more than the rate on 10-year Treasuries, near the lowest since 2011.

The final five utilities in the S&P 500 report earnings this week. So we’re bound to hear more about that “favorable weather.”

Investors in the group may want to wish for some more extreme weather -- namely a hot U.S. summer that will boost demand for power to run air conditioning. Otherwise Ted Koppel may have to put his shirt back on.

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