As 2011 drew to a close I began to hear commentators contemplating whether utilities were in a bubble. During the year the utilities index was the best performing sector, the DJU up 14.7% while the S&P (NYSEARCA:SPY) was basically flat on the year.
We know why the sector was up, a flight to safe, high quality dividend payers with above-average yields. And utilities give the added protection of being basically insulated from the turmoil in the eurozone.
In my experience I have learned a couple of things. First, once the mass media catches on and starts asking about a bubble, one is probably developing. Second, markets have an ugly tendency to revert to the mean. If we accept the premise that utility yields are lower than average because the trade is becoming crowded, and we accept the premise that markets revert to the mean, what happens next? Well, one of two things. Either everyone runs for the exit at the same time because growth and risk are back in vogue or slowly, over time, the yields will re-inflate due to raising dividends with little or no capital appreciation.
I pulled a snapshot of five utilities in my dividend screener. Of the five I have been in ConEd ED for quite some time, but possibly not much longer.
In my worksheets I run a statistical look at the historical dividend yields. I go back 20 years and capture the data on the ex-div date. For quarterly payers this gives me 80 data points for the analysis. I look at current yield, the average yield over the data points, mean yield, maximum yield, minimum yield, standard deviation, and average growth rate for the dividend. For utilities, dividend growth rates are particularly important. If you buy a utility at the wrong part of the cycle chances are your annual increases are not going to compensate for the potential drop in capital value. Utilities of course tend not to grow their payout rate much more than inflation. Buying a utility at the right point in the cycle is key. In my analysis I will typically not buy a utility unless the yield is 2 standard deviations above the norm.
My chart shows that the five utilities selected are candidates for a pull back and the price I would look at buying.
(Click chart to expand)
So while I do not think utilities represent value, is there a bubble? As of now, I would say no. While the yield of ED is nearing 2 standard deviations below normal (my personal trigger point to sell) the rest are not so far from the norm that I would be all utilities out the window. At this point I would continue to hold and watch and happily collect my dividends. However, there will come a time when the utility sector is played out and yield seekers will need to look elsewhere.