ATO - RYU: Utilities Dashboard For February

Summary

• Gas utilities are close to their historical average in valuation and quality.
• Water utilities are significantly overvalued.
• Invesco S&P 500 Equal Weight Utilities ETF: an equal-weight alternative to XLU.
• 10 utilities stocks cheaper than their peers in February.

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 Invesco S&P 500 Equal Weight Utilities ETF ( RYU ), whose 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

Value scores have improved due to a short-term downtrend in utilities stock prices. Quality has improved in gas and is unchanged elsewhere.

Momentum

The next chart plots median returns by subsector.

Interpretation

Gas utilities are close to 11-year averages in valuation and quality metrics. It is the most attractive industry in the sector right now. Electricity and water are also close to the historical baseline in quality, but they are overvalued by about 14% and 29%, based on the same methodology.

Fast Facts on RYU

The Invesco S&P 500 Equal Weight Utilities ETF ( RYU ) has been tracking the S&P 500 Equal Weight Utilities Plus Index since 11/01/2006. It has a 12-month distribution yield of 2.41%. The expense ratio is 0.40%, while XLU charges only 0.10%.

All constituents have the same weight after every rebalancing, but they may drift with price action. The next table lists the top 10 holdings, with an aggregate weight of 34.5%. These are the stocks with the best momentum since the last rebalancing. Risks related to individual companies are lower than in XLU, where the top 10 holdings weigh 59% of the fund, and the top name, NextEra Energy ( NEE ), represents about 15% of asset value.

RYU is a bit cheaper than XLU regarding the usual valuation ratios:

Data: Fidelity.

Despite their difference in weighting, the performance and risk metrics of RYU and XLU since inception are extremely close (see table below).

Data calculated with Portfolio123.

In summary, RYU is interesting for investors looking for exposure to utilities without the concentration in top holdings of capital weighted funds. However, XLU is a better instrument for trading and tactical allocation strategies, thanks to higher trading volumes.

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 0.0475 (or price/earnings below 21.05) 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: