Which matters most: Cost? Price? Sales? Regulation?
Many investors no longer think of electric utility stocks primarily as dividend-rich, income-oriented investments. Instead, they have begun to consider new criteria in evaluating utility stocks (em criteria that might help explain some of the variations in equity price performance now seen among various utility companies. Such criteria might include changes in state regulation, or company-specific data that track competitive indicators such as production costs, asset mix, price advantage, or customer profile.
How well do these new criteria predict utility stock performance, as measured by market-to-book ratio (M/B, or equity share price divided by book value)?
As we have found in our most recent study, at least three-fourths of the variance in M/B ratios observed in June 1996 across 73 utilities can now be explained by differences in regulation and certain competitive indicators: 1) return on equity (ROE), 2) industrial prices, 3) embedded cost of generation capacity, and 4) the relative progress achieved by state regulators toward industry restructuring. This level of explanation (75 percent) marks an improvement over our previous study, conducted last year and published in PUBLIC UTILITIES FORTNIGHTLY, %n1%n in which we found we could use ROE and stranded-cost estimates by bond credit rating agencies to explain 51-55 percent of the variance in year-end 1995 M/B ratios across 69 utilities.
Stranded Costs: Still Significant