Let's talk natural resources, actually, let's talk about water as an investment. Water typically isn't perceived to offer a lot of value for investors, but that is because we - investors- have become so enamored with high growth stocks that we quit paying attention to the value based stocks that are the bedrock, or should be the bedrock of an investment portfolio. So, let's first look at why water is a good investment, and then we will look at a few ways you can invest in water.
Water is a good investment based on an idea in economics called the "Malthusian Theory". This is an economic theory that basically states: As population increases resources will become more costly to produce, and eventually population will outpace natural resources and we will have a Malthusian Catastrophe. This idea can be seen in gas prices, as oil becomes more scarce the cost of gasoline increases, and the increase has pushed us into a "Green Revolution" with companies such as Tesla Motors (NYSE:TM). So, what is so special about water? To answer it simply. You can replace gasoline with fuel-cells, but what can you replace water with? The answer is nothing. We can purify, filter, drill for, desalinate, and pump water. We cannot substitute water.
Beyond theory: Environmental, political, and economic impact in 2014.
Knowing there is no substitute for water, we can start to look at the bigger picture. There have been two notable water disasters in the United States this year (West Virginia, and the E. coli outbreak in Portland). Then when you consider that fracking is becoming more commonplace around the world, and that fracking uses 1 to 8 million gallons of water, which is turned into a toxic compound (not going back into the water supply) it becomes rather clear that we will be facing a water crisis.
What should investors look for when investing in water?
So, water is a pretty solid investment: We are using it in an unsustainable fashion, and we as humans have no substitute, which makes it better than cigarettes and alcohol as a defensive investments.
The downsides, and there are plenty to consider: Regulated utilities, can't act in a free market capacity, which is good for us, but bad for their profits. Interest rates can make or break water investments. The surrounding area's economic stability, and finally customer growth (which relates back to economic stability) can all impact water investments.
Regulated utilities are, well, regulated. So, you don't have to worry about extreme variations in your water bill. So, if the company is mismanaged and overspends they can't increase the prices on their customers.
Interest rates, are important to consider because if rates increase there is a very high chance that utilities will incur higher interest expense when they roll over their long-term debt, and utilities typically have a high debt-to-capital ratio. This will often push investors into other sectors that have a lower debt-capital ratio.
Economic stability, looks at a broad range of potential problems a utility could face from weather, to threat of an organized militia.
Customer growth, ideally occurs when the housing market is booming. Typically utilities will do worse as the housing market declines.
Now, we have gone over the macro-economic concept as to why water would be a good investment, and we have covered the concerns for investing in water. Let's look at how you can invest in water for the long run.
The easiest way to gain exposure to water is by investing in PowerShares Water Resources ETF (NYSEARCA:PHO). The fund seeks to follow the NASDAQ QMX U.S. Water Index, and as you can see the fund correlates incredibly well with the Index.
Source: PHO homepage
The benefit of investing in PHO is that the ETF is managed, and well diversified. That allows you to make one investment and gain exposure across the entire water sector; industrial, utilities, health-care, information technology, and materials. So, while the brunt of the article above was in regards to utilities, there are countless companies in different sectors focused on solving the coming water crisis, and this ETF wraps them all up in a nice package for your portfolio.
Then of course you could invest in individual stocks: I don't advise the individual investor to jump into the individual water based stocks, but if I have to make a recommendation I would recommend utilities. The utilities provide a safe way to generate income passively (through dividends), while having the stock appreciate in your portfolio.
One stock I consider to be a buy is: Consolidated Water (CWCO).
CWCO has a 1 year target estimate of $14.33, offers a 2.40% annual yield ($00.075 quarterly dividend) and a Beta of 0.92, meaning the stock is fairly stable (in relation to market movement). The only concern I have is that the P/E currently is pushing 30, which means people have priced it at a premium.
Thomson/First Call shows a mean target price of $14.33, a high target price of $18, and a low of $12.00. This allows me to say with some confidence that the stock's value should be appreciating over the next few months.
I like this stock personally due to the Beta, I want to hold this stock for the long haul, it provides a consistent sustainable dividend, the company is diversified in its offerings which provides another level of comfort for me. The technical analysis on the stock also are showing positive signs, but again this is not a short term investment.
In conclusion, I would advise investors to dive into PHO. It is the easiest way to gain exposure to the market, and it offers incredible flexibility. PHO pays a quarterly dividend of $0.09, and also has active options chains allowing for investors to trade covered calls and puts for additional income while holding the investment. I would only advise CWCO for the active investor, or as a passive investment that you will check up on once or twice a year.
Disclosure: The author is long CWCO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.