DUKB - FUTY: Utilities Dashboard For August

• Gas is the least-overvalued utilities industry.
• Water and electricity subsectors are overvalued by about 30% relative to 11-year averages.
• FUTY: an alternative to XLU.
• 10 stocks cheaper than their peers in August.

This monthly article series shows a dashboard with aggregate industry metrics in utilities. It is also a top-down analysis of sector exchange-traded funds ("ETFs") like the Utilities Select Sector SPDR ETF ( XLU ) and the Fidelity MSCI Utilities Index ETF ( FUTY ), whose largest holdings are used to calculate these metrics.

Shortcut

The next two paragraphs in italic describe the dashboard methodology. They are necessary for new readers to understand the metrics. If you are used to this series or if you are short of time, you can skip them and go to the charts.

Base Metrics

I calculate the median value of five fundamental ratios for each industry: Earnings Yield ("EY"), Sales Yield ("SY"), Free Cash Flow Yield ("FY"), Return on Equity ("ROE"), Gross Margin ("GM"). The reference universe includes large companies in the U.S. stock market. The five base metrics are calculated on trailing 12 months. For all of them, higher is better. EY, SY and FY are medians of the inverse of Price/Earnings, Price/Sales and Price/Free Cash Flow. They are better for statistical studies than price-to-something ratios, which are unusable or non available when the "something" is close to zero or negative (for example, companies with negative earnings). I also look at two momentum metrics for each group: the median monthly return (RetM) and the median annual return (RetY).

I prefer medians to averages because a median splits a set in a good half and a bad half. A capital-weighted average is skewed by extreme values and the largest companies. My metrics are designed for stock-picking rather than index investing.

Value and Quality Scores

I calculate historical baselines for all metrics. They are noted respectively EYh, SYh, FYh, ROEh, GMh, and they are calculated as the averages on a look-back period of 11 years. For example, the value of EYh for hardware in the table below is the 11-year average of the median Earnings Yield in hardware companies.

The Value Score ("VS") is defined as the average difference in % between two valuation ratios (EY, SY) and their baselines (EYh, SYh) . FY is reported for consistency with other sector dashboards, but it is ignored in utilities ’ s core to avoid some inconsistencies. The same way, the Quality Score ("QS") is the average difference between the two quality ratios (ROE, GM) and their baselines (ROEh, GMh).

The scores are in percentage points. VS may be interpreted as the percentage of undervaluation or overvaluation relative to the baseline (positive is good, negative is bad). This interpretation must be taken with caution: the baseline is an arbitrary reference, not a supposed fair value. The formula assumes that the two valuation ratios are of equal importance.

Current data

The next table shows the metrics and scores as of last week's closing. Columns stand for all the data named and defined above.

Value and Quality chart

The next chart plots the Value and Quality Scores by industry. Higher is better.

Evolution since last month

The value score has significantly deteriorated in water utilities, and to a lesser extent in electricity.

Momentum

The next chart plots momentum data.

Interpretation

Gas utilities are the less overvalued subsector, by about 15% relative to 11-year averages. Water and electricity are overvalued by about 35% and 30%, respectively. Quality is close to the historical baseline in the three subsectors. Gas also has the highest 12-month median momentum with +18.5%, followed by electricity at 10.7%.

Fast facts on FUTY

The Fidelity MSCI Utilities Index ETF ( FUTY ) has been tracking the MSCI USA IMI Utilities 25/50 Index since 10/21/2013. The expense ratio of 0.08% is a bit cheaper than for XLU (0.10%).

As of writing, the fund has 69 holdings. The next table lists the top 10 holdings with fundamental ratios and dividend yields. Their aggregate weight is 54.3%.

Ratios: Portfolio123

FUTY and XLU show similar performance and risk metrics since FUTY inception (see next table). The difference in annualized return, drawdown and risk-adjusted performance (Sharpe ratio) is insignificant.

Data calculated with Portfolio123

In summary, FUTY is a good instrument with cheap fees for investors seeking a capital-weighted exposure in utilities. It has more holdings than XLU (currently 69 vs. 30), but past performance is almost identical. Tail holdings have a low aggregate weight relative to S&P 500 companies in this sector. Long-term investors may indifferently choose XLU or FUTY. However, XLU is preferable for tactical allocation and trading because it has much more trading volume. The fund has significant risk exposure to the top three holdings: they represent 27.6% of asset value. NextEra Energy alone weighs almost 14%. If such concentration is a concern, the Invesco S&P 500 Equal Weight Utilities ETF ( RYU ) is a better choice.

Dashboard List

I use the first table to calculate value and quality scores. It may also be used in a stock-picking process to check how companies stand among their peers. For example, the EY column tells us that an electricity company with an Earnings Yield above 0.0411 (or price/earnings below 24.33) is in the better half of the industry regarding this metric. A Dashboard List is sent every month to Quantitative Risk & Value subscribers with the most profitable companies standing in the better half among their peers regarding the three valuation metrics at the same time. The list below was sent to subscribers several weeks ago based on data available at this time.

It is a rotating list with a statistical bias toward excess returns on the long-term, not the result of an analysis of each stock.

For further details see: