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Warren Buffett this week said Berkshire Hathaway Inc. (BRKA) is considering investing in more utilities, following the investment company's purchase of PacificCorp from electric company Scottish Power Plc in March. So we decided to take a look at the electric utility industry. Here, we found PPL Corp. (NYSE:PPL) on the Reuters Select value stock screen for Income Stocks.

We started off with a list of the 164 utilities in the Reuters.com stock universe and filtered for names that recently appeared on at least one Reuters Select stock screen. This reduced our list to 24 companies. (Click here to download an Excel spreadsheet comparing utilities, particularly those that recently appeared on the Reuters Select stock screens.)

We then filtered for the electric utilities that appeared on the screens, leaving us with a list of 15.

We wanted to focus on companies that have a history of growing faster than the group. To accomplish this, we looked at utilities where the five-year average earnings per share [EPS] growth rate is faster than the industry average. Of course, we also wanted to steer clear of companies that had been growing at a solid clip, but recently experienced a slowdown. To weed out those utilities, we filtered for companies where the EPS growth rate in the trailing 12-month [TTM] span has outpaced the industry norm. This left us with a total of four names.

To zero in on the utilities where EPS has improved thanks at least partially to enhanced efficiency, we filtered for the names with superior profit margins. A potential problem here, though, is that differences in effective tax rates could help to buoy margins. To avoid such complications, we looked at operating margins and screened for the utilities where margins are not only wider than the industry average over both the TTM and five-year periods, but have also improved recently compared with its longer-term mean. This left us with two companies.

We then turned our attention to valuation, and looked for the utility that appeared the "cheapest." While it would have been simple enough to just look at comparative valuations, such as price to earnings (P/E) or P/Sales based on historical performance, we opted to consider analyst expectations of future performance. We started with a look at the forward P/E, which is the current stock price divided by the consensus estimate for 2006 and 2007 EPS. On the basis of forward P/E ratios, CLP Holdings (OTCPK:CLPHY) appeared to be more attractively priced. But, then we took into consideration analyst estimates for long-term EPS growth and examined the PEG ratio - forward P/E divided by long-term EPS growth. This is where PPL Corp. pulled out ahead.

On average, analysts in a Reuters poll expect CLP's earnings to fall going forward, while they believe that PPL Corp. will grow its earnings at an average annual pace of nearly 8 percent. This yielded PEG ratios of 1.8 and 1.7, as indicated below.

Although PEG ratios this high are well out of the range of many value-oriented investors, who typically prefer numbers south of 1.0, its relatively lofty valuation did not prevent PPL from appearing on the Reuters Select value screen for income stocks, which seeks firms that are paying above-average dividends.

The screen starts off by filtering for companies that have a dividend yield in excess of 2 percent. As indicated below, PPL easily clears this hurdle. Further, we want to see some signs that the amount shareholders receive has been growing, so the screen requires that dividend growth must be at least 10 percent above the industry average. Given the company's above-average earnings growth, it is not surprising to see that dividends have also improved at a clip that easily surpasses the industry norm.


Learn about Dividend Ratios

While it is nice to see shareholders reap the benefits of a company's growth, we also want to make sure that management is not doling out so much to shareholders that operations might suffer, so it is important to examine the payout ratio - that portion of net income that is paid out in the form of dividends. The screen requires that the payout ratio must be no more than 25 percent above the industry average. As we see above, PPL's payout ratio still has room to grow before hitting the industry average, let alone the ceiling permitted by the screen.

At the time of publication, Erik Dellith did not directly own puts or calls or shares of any company mentioned in this article. He may be an owner, albeit indirectly, as an investor in a mutual fund or an Exchange Traded Fund.

Note: This is independent investment and analysis from the Reuters.com investment channel, and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by Reuters.com.

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Source: Following Buffett Into Utilities