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The utility companies offer nifty dividends to share their profits with the investors. They offer high and stable dividends, as well as significant capital appreciation. While many investors discard utility stocks as boring investments, some companies in this sector returned outstanding profits to shareholders. In the last 15 years, Southern Company (SO) and Dominion Resources (D) shareholders enjoyed annual returns of 11.10% and 9.44%, respectively. In the same period, regulated utility stocks returned 8.13%, and diversified utility stocks returned 8.91%, whereas S&P 500’s (SPY) annual return was only 6.03%.

Performance of utility companies is mostly compared with long-term government and corporate bonds. Thanks to the Fed's massive expansionary policy, government bonds yield almost nothing, if not negative. As Seeking Alpha contributor Norman Tweed suggests, due to this low yield, investors have been bidding up the prices for utility stocks, driving these stocks to significantly higher levels in 2011.

Here is the year-to-date performance review of the largest U.S.-based utility stocks ranked according on their market-caps:

Company

Market Cap

Yield

Performance (YTD)

Southern Company (SO)

37144.82

4.36%

17.47%

Dominion Resources (D)

29578.85

3.83%

24.08%

Exelon (EXC)

29514.70

4.71%

11.17%

Duke Energy (DUK)

27234.10

4.89%

19.58%

NextEra Energy (NEE)

24068.60

3.86%

13.04%

American Electric (AEP)

19011.08

4.67%

13.83%

FirstEnergy Corp. (FE)

18991.37

4.84%

27.59%

PG & E Corp. (PCG)

17272.61

4.24%

-7.30%

Public Service E. (PEG)

17200.30

4.03%

10.32%

PPL Corporation (PPL)

17159.18

4.71%

17.30%

Consolidated Ed. (ED)

16998.76

4.14%

21.19%

Progress Energy (PGN)

15445.88

4.73%

27.13%

Edison Int. (EIX)

13266.98

3.14%

8.24%

Sempra Energy (SRE)

12971.63

3.55%

6.09%

Xcel Energy (XEL)

12554.95

4.01%

13.59%

Entergy Corp. (ETR)

12281.71

4.81%

1.14%

EQT Corporation (EQT)

9853.90

1.33%

48.89%

AES Corporation (AES)

9114.96

-4.35%

CenterPoint E. (CNP)

9066.56

3.71%

39.97%

DTE Energy (DTE)

8855.96

4.49%

19.60%

AVERAGE

4.11%

16.43%

I am a big fan of utility stocks. They have been slow but steady upside movers. In a low-interest environment, their yields offer a better alternative to government bonds. In an inflationary environment, given their monopoly status, they can also protect investors against inflation risk.

In a recent article, I showed how these stocks outperformed both bonds and equities over the last two decades. However, after making significant returns since January, it is hard to find a good deal among utilities. Therefore, I run my FED+ Fair Value estimation model on the largest 20 U.S. - based utilities. Here is what I found:

Company

Price

Fair Value Range

DD O-Metrix

Southern Company

$43.31

$31.08 - $50.88

4.10

Dominion Resources

$51.37

$36.08 - $56.60

3.49

Exelon Corp.

$44.57

$37.82 - $59.12

4.31

Duke Energy

$20.46

$17.70 - $34.65

5.21

NextEra Energy

$57.04

$56.69 - $91.98

5.35

American Electric

$39.42

$37.40 - $66.32

5.59

FirstEnergy Corp.

$45.41

$30.43 - $61.51

3.61

PG & E Corp.

$42.94

$39.17 - $68.72

5.03

Public Service Enterprise

$33.99

$35.34 - $55.32

5.63

PPL Corporation

$29.70

$24.71 - $43.16

3.91

Consolidated Edison

$58.04

$42.92 - $81.34

3.88

Progress Energy

$52.43

$37.00 - $71.05

4.19

Edison International

$40.72

$32.07 - $64.99

3.02

Sempra Energy

$54.15

$59.50 - $99.51

5.80

Xcel Energy Inc.

$25.91

$21.19 - $38.18

4.35

Entergy Corporation

$69.01

$68.58 - $117.20

5.01

EQT Corporation

$65.93

$59.66 - $81.32

5.00

AES Corporation

$11.65

$9.36 - $18.20

0.24

CenterPoint Energy

$21.29

$15.68 - $23.46

4.04

DTE Energy Co.

$52.30

$45.90 - $85.97

4.86

AVERAGE

4.33

(Data from Finviz/Morningstar, current as of October 28. You can download FED+ Fair Value Estimator here.)

I have been using the FED+ model for a while, and so far it was very good at distinguishing the bubble stocks from value stocks. One of the critical assumptions in this model is the growth assumption. It uses the 5-year annualized EPS growth projections based on analyst estimations. While these estimations can have large deviations for volatile sectors, utility stocks have quite stable revenues and income structures. Therefore, it is relatively easier to accurately estimate their future growth.

As one can see from the table above, almost all of the utility stocks are trading within their fair-value range. However, given the high fixed-cost investment structure of these companies, one should look for stocks that are trading near the lower-end of the fair-value range.

I also calculated the Double Dividend O-Metrix scores for utility companies. One striking result was the confirmation of these two ranking systems with each other. Stocks that are trading at the lower end of their fair-value range have higher-than-average DD O-Metrix scores. Investors might use the following quick formula to choose the best utility dividends for long-term profits:

DD O-Metrix = 5 x (2 x Dividend Yield + EPS Growth) / (PE Ratio)

Based on the formula above, Duke Energy, NextEra Energy, American Electric Power, Public Service Enterprises, and Sempra Energy have significantly higher-than average scores. Therefore I expect these companies to outperform their peers in the long-term. Please note that both FED+ Valuation and O-Metrix scores are powerful tools that can be added to your knowledge database. However, as always, investors should do their own diligence before making any investment decisions.

Source: Top Utility Stocks For The Next 5 Years