# Backtested Strategy: 7 High-Yield Utility Stocks Undervalued by the Graham Number

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Includes: ATO, AVA, DTE, ETR, POR, SCG, WR
by: Kapitall

This is our third time writing about high-yield utilities undervalued by the Graham number – we also wrote about this screen on May 13 and April 8, 2011. On May 13, the screen produced 8 companies.

Since then, 6 out of 8 companies mentioned in that article have outperformed the S&P 500 index (a success rate of 75%). The screen averaged a price-weighted rate of return of 1.9% vs. an index return of -3.14%.

Click here to access a full breakdown of the screen's past performance.

Many investors buy utilities stocks for their dividends or generally low volatility relative to the market. Here we present an interesting list of high-dividend utilities that are currently undervalued based on the Graham equation.

Benjamin Graham, the man who developed the equation for the Graham number, was a former mentor of Warren Buffett and is the so-called “Godfather” of value investing.

The Graham Number, or the maximum price an investor should pay for a stock, is derived using only two data points: current earnings per share and current book value per share.  The Graham Number = Fair Value of a Stock = Square Root of (22.5) x (TTM Earnings per Share) x (MRQ Book Value per Share).

The math of the Graham number is relatively straightforward. It is predicated on the belief that the price-to-earnings (P/EPS) ratio should be no more than 15, and the price-to-book value (P/BVPS) ratio should be no more than 1.5. Therefore we only include companies that meet both of these criteria.

From these criteria, the product of the two should not be more than 22.5. In other words, (P/EPS of 15) x (P/BVPS of 1.5) = 22.5, from which the equation was created.

With past performance in mind, we decided to run the same screen today, and see which companies show up in the update.

We ultimately found 7 high-yield utilities that met all of these requirements to appear undervalued. (Click here to access an interactive list snapshot of all stocks mentioned below.)

Do you think these are good dividend investments? Use this list as a starting-off point for your own analysis.

List sorted by potential upside implied by the Graham equation.

1. Portland General Electric Company (NYSE:POR):
Electric Utilities Industry. Market cap of \$1.95B. Dividend yield at 4.1%. BVPS at \$21.80, diluted EPS at \$2.22. Graham number = sqrt(22.5 x \$21.80 x \$2.22) = \$33.00. Current price at \$25.52 (implies a potential upside of 29.31%). The stock appears to have good liquidity to back up its dividend-- current ratio at 1.54 and quick ratio at 1.42. The stock has gained 42.69% over the last year.

2. Entergy Corporation (NYSE:ETR): Electric Utilities Industry. Market cap of \$12.35B. Dividend yield at 4.78%. BVPS at \$47.88, diluted EPS at \$6.95. Graham number = sqrt(22.5 x \$47.88 x \$6.95) = \$86.53. Current price at \$69.18 (implies a potential upside of 25.08%). The stock has lost 2.88% over the last year.

3. Avista Corp. (NYSE:AVA): Diversified Utilities Industry. Market cap of \$1.44B. Dividend yield at 4.4%. BVPS at \$20.14, diluted EPS at \$1.87. Graham number = sqrt(22.5 x \$20.14 x \$1.87) = \$29.11. Current price at \$25.05 (implies a potential upside of 16.21%). The stock has gained 32.12% over the last year.

4. SCANA Corp. (NYSE:SCG): Diversified Utilities Industry. Market cap of \$5.0B. Dividend yield at 4.97%. BVPS at \$29.59, diluted EPS at \$2.97. Graham number = sqrt(22.5 x \$29.59 x \$2.97) = \$44.47. Current price at \$39.03 (implies a potential upside of 13.93%). The stock has gained 11.26% over the last year.

5. DTE Energy Co. (NYSE:DTE):
Electric Utilities Industry. Market cap of \$8.42B. Dividend yield at 4.73%. BVPS at \$40.11, diluted EPS at \$3.41. Graham number = sqrt(22.5 x \$40.11 x \$3.41) = \$55.47. Current price at \$49.45 (implies a potential upside of 12.18%). The stock has gained 10.89% over the last year.

6. Atmos Energy Corporation (NYSE:ATO): Gas Utilities Industry. Market cap of \$2.92B. Dividend yield at 4.21%. BVPS at \$26.28, diluted EPS at \$2.22. Graham number = sqrt(22.5 x \$26.28 x \$2.22) = \$36.23. Current price at \$32.39 (implies a potential upside of 11.86%). The stock has gained 20.02% over the last year.

7. Westar Energy, Inc. (NYSE:WR):
Diversified Utilities Industry. Market cap of \$3.04B. Dividend yield at 4.79%. BVPS at \$21.21, diluted EPS at \$1.79. Graham number = sqrt(22.5 x \$21.21 x \$1.79) = \$29.23. Current price at \$26.59 (implies a potential upside of 9.92%). The stock is a short squeeze candidate, with a short float at 13.06% (equivalent to 16.52 days of average volume). The stock has gained 26.37% over the last year.

*Book value and EPS data sourced from Yahoo! Finance, all other data sourced from Finviz.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.