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The Top Utility Stocks: New Challenges Ahead

Utilities showed strong gains last year, but other industries are gaining ground.

Fortnightly Magazine - March 2007

have a dampening effect on prices—in this case, the prices of utility stocks.

The last issue is financial in nature. Utilities long have recognized that they are exposed to changes in interest rates. When rates go up, utility dividends don’t look as attractive.

Another long recognized relationship involves the tradeoffs between equities and bonds ( i.e., interest rates) and in our case, between utility stocks (as quasi bonds) and equities. In examining the relationship between non-utility equities (represented by the Dow Jones Industrial Average) and utilities (represented by the Dow Jones Utilities Index, utilities may be viewed as being overvalued. This would set the stage for a future correction. Regardless of what the overall market does, utilities would not fare as well or suffer worse to restore the traditional relationship between equity groups.

Our analysis of utilities groups indicates that Gas Utilities and Energy Delivery companies didn’t do as well as those with upstream gas or power plant assets and investments. With the issues noted above, will the situation flip? Will Gas Utilities and Energy Delivery companies outperform the other groups? Or will all groups suffer and Gas Utilities and Energy Delivery companies suffer negative TSR ( i.e., dividends not making up for the fall in share price)?

Forecasting stock prices is foolish. However, a safe bet is that utilities will face significant issues in the coming years, and how well they respond undoubtedly will affect how well they reward their investors.

 

Endnotes:

1. The Dow Jones Utilities Index consists of Dominion Resources, Con Ed, PSEG, TXU, FirstEnergy, Exelon, AEP, Southern Co., PG&E, Edison International, Duke, NiSource, Williams, CenterPoint, and AES.

2. The one-year return measured returns in 2006; the three-year return measured returns for the 2004-2006 period. Each “year” reflected a Jan. 1 through Dec. 31 perspective. Dividends used in the TSR calculation were “paid” during that period.

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