Utility Sector ETFs in the Danger Zone

by: David Trainer

We rec­om­mend investors avoid all util­ity sec­tor ETFs (pdf). There are no ETFs in the util­ity sec­tor with an attractive-or-better rat­ing. None of the ETFs ranks bet­ter than the S&P500 (NYSEARCA:SPY).

Investors should sell the fol­low­ing dangerous-rated util­ity sec­tor ETFs:

  1. ProShares Ultra Util­i­ties (NYSEARCA:UPW)
  2. First Trust Util­i­ties AlphaDEX Fund (NYSEARCA:FXU)
  3. Pow­er­Shares S&P Small­Cap Util­i­ties Port­fo­lio (NASDAQ:PSCU)
  4. Pow­er­Shares Dynamic Util­i­ties (NASDAQ:PUI)
  5. Rydex S&P Equal Weight Util­i­ties ETF (NYSEARCA:RYU)

Investors seek­ing to out­per­form the mar­ket with expo­sure to the util­ity sec­tor should invest only in the attractive-or-better rated stocks in the sec­tor. Cur­rently, there are only two: DPL, Inc. (NYSE:DPL) and Pub­lic Ser­vice Elec­tric and Gas Com­pany (NYSE:PEG).

The util­ity sec­tor is one of four sec­tors to earn our “dan­ger­ous” rat­ing. For our pre­dic­tive rat­ings on all ten sec­tors, see our 3Q11 Sec­tor Roadmap (pdf) report. Last quar­ter, the util­ity sec­tor got a “neu­tral” rat­ing. As val­u­a­tions rose and the eco­nom­ics of util­ity com­pa­nies declined, the invest­ment merit of com­pa­nies in the sec­tor deteriorated.

The “dan­ger­ous” rat­ing for the sec­tor does not nec­es­sar­ily mean there are no good stocks or ETFs in the sec­tor, it means the like­li­hood of them is low. So, investors must read carefully.

Fig­ure 1 shows the invest­ment merit land­scape for util­ity stocks accord­ing to our rat­ing system.

(Click charts to enlarge)

Fig­ure 1: Util­i­ties Sec­tor – Allo­ca­tion & Hold­ings by Risk/Reward Rating

Sources: New Con­structs, LLC and com­pany filings

There are sim­ply not a lot of good stocks to choose from in the util­ity sec­tor. The util­ity sec­tor has only 4% of its value in attractive-or-better-rated stocks and 39% of its value in dangerous-or-worse-rated stocks.

Fig­ure 2: Hold­ings Count of Util­i­ties Sec­tor ETFs

Sources: New Con­structs, LLC

Fig­ure 2 shows clearly that util­ity sec­tor ETFs are not all made the same. Dif­fer­ent ETFs have mean­ing­fully dif­fer­ent num­bers of hold­ings and, there­fore, dif­fer­ent allo­ca­tions to hold­ings. Given the dif­fer­ences in hold­ings and allo­ca­tions, these ETFs will likely per­form quite differently.

Con­se­quently, it is impor­tant to derive a pre­dic­tive rat­ing for ETFs based on analy­sis of the under­ly­ing qual­ity of earn­ings and val­u­a­tion of the stocks in each ETF.

Fig­ure 3 shows how the 9 util­ity sec­tor ETFs stack up ver­sus each other, the over­all sec­tor and the S&P 500 based on their risk/reward rat­ings and the allo­ca­tion of their hold­ings by rating.

Fig­ure 3: Invest­ment Merit Based on Hold­ings and Allocations

Sources: New Con­structs, LLC; and com­pany filings

Attrac­tive ETFs:

We find no attractive-or-better-rated util­i­ties ETFs.

Neu­tral ETFs:

VPU, IDU, XLU, and FUI allo­cate their value in a way that earns them a neu­tral over­all risk/reward rat­ing. We rec­om­mend investors buy the attrac­tive stocks in this sec­tor before buy­ing any of the U.S. equity util­i­ties ETFs.

Dan­ger­ous ETFs:

We rec­om­mend investors sell UPW, FXU, PSCU, PUI, and RYU because of their dan­ger­ous over­all risk/reward rating.


Our analy­sis is based on aggre­gat­ing results from our mod­els on each of the com­pa­nies included in every ETF and the over­all sec­tor (90 com­pa­nies) based on data as of July 12, 2011. We aggre­gate results for the ETFs in the same way the ETFs are designed.

Our goal is to empower investors to ana­lyze ETFs in the same way they ana­lyze indi­vid­ual stocks.

Given the suc­cess of our rat­ing sys­tem for indi­vid­ual stocks, we believe its appli­ca­tion to groups of stocks (i.e. ETFs and funds) helps investors make more informed ETF and mutual fund buy­ing deci­sions. Barron’s fea­tured our uniquely pre­dic­tive ETF research in “The Dan­ger Within”.

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