Stranded Costs: Is the Market Paying Attention? (A Look at Market-to-Book Ratios)

Fortnightly Magazine - May 15 1996
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Investors are taking stock

of utility exposure to price competition.The utility trade press and even the general financial press have featured the views of regulators, utility executives, legislators, and various consumer advocates on the stranded-cost question. Stranded costs easily represent the most contentious issue facing the electric industry as it moves to an era of competition. The financial analysts have weighed in as well, from the fixed income as well as the equity side of the house.

But rarely does one find evidence of what utility shareholders are saying about stranded costs and competition. That's because they speak with their wallets and not with their mouths. Utility stock performance in 1995 provides evidence that equity investors are taking serious account of the exposure of utilities to stranded costs and competition. Those utilities most exposed saw their stocks trading at lower market-to-book ratios.

Just as electric producers compete for sales, analysts compete to develop methods to estimate exposure to stranded costs. In this case, we started with data on stranded investment contained in recent reports from Moody's and Standard and Poor's, and used that information to study the 1995 year-end, market-to-book (M/B) ratios of stock prices for some 69 utilities. We found that we could explain approximately 20 percent of the differences among the M/B ratios in terms of estimates of stranded costs. Moreover, when we considered differences across utilities in earned returns on equity, we could then explain fully half the variance among M/B ratios.

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