Utilities: Should You Buy, Sell, or Hold?

Although the S&P 500 has advanced 32% since the March 9 market bottom, the rally has been quite selective from a sector perspective. Groups decimated during the recent bear market have rallied the most. Financial shares are up big after losing 81% from September 30, 2007.

With investors demonstrating healthy risk appetite, defensive sectors have generally lagged. Utilities Select Sector SPDR (XLU), for example, is up just 15%.

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Things have been worse for shares of individual utility companies like Consolidated Edison (ED), FirstEnergy (FE), Southern Company (SO), and Wisconsin Energy (WEC). These stocks trade fairly close to their 52-week lows. At current prices ED, FE, and SO shares carry plump dividend yields nearing 6% or more. WEC's yield is lower at 3.7%.

So, why are Utilities out of favor?

Part of the reason is that the weak economy has quashed demand at most electric utilities. With the nation gripped in a recession, most state regulators are reluctant to grant healthy rate increases. Weak demand is offsetting benefits from lower fuel prices. As a result, reduction in 2009 earnings forecasts has been quite common among utilities.

Other reasons for underperformance include investors' preference for more volatile stocks during a period when the stock market has been buoyant. In recent weeks, the up-tick in bond yields is also pressuring utility stocks.

So, should you buy, sell, or hold Utilities?

Selected utility stocks such as ED, FE, and SO are oversold and due for a short-term bounce. Nimble traders can look here to make a quick buck at relatively low risk. With earnings outlooks less than stellar, intermediate and long-term investors will be better off looking elsewhere.

Disclosure: I do not have positions on XLU or FE. I have long positions of less than 100 shares in ED and SO.

Comments

[ArtfulDodger:]

You are forgetting cap-&-trade as another reason some of us have utilities off limits.

Until I know which ones will receive political favors and are able to pass on the costs if cap-&-trade passes, they're off limit for me.

But I wish you well with your investments.

May 27 09:02 AM

[PastTense:]

If there is another explosion in electrical utilities' energy costs, many utilities will have difficulties passing these costs on (their regulators will be slow in allowing price increases). So I think you need to look closely at the state regulatory climate for each particular utility of interest.

May 27 09:22 AM

[BillyS:]

There is a curious paralell between the pressure on utilities that are heavy into coal for their major fuel source. New Fed rules will require astronomical capital investment to clean coal burning sufficiently to meet newly arriving requirements.

May 27 09:49 AM

[notsosmart:]

rising unemployment will not allow raising rates while this whole going green business will cost a fortune.

May 27 03:22 PM

[ArtfulDodger:]

Ah ha, notsosmart, it seems you're a sarcastic rascal, and you are indeed so smart.

Your point below makes it even more dangerous to invest in utilties at this point --- and it's one I had not thought of. Thank you for bringing it up.


On May 27 03:22 PM notsosmart wrote:

> rising unemployment will not allow raising rates while this whole
> going green business will cost a fortune.

Jun 08 12:43 PM