Have New Money To Invest? Which Sectors To Buy? Which To Avoid?

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Includes: AAPL, AEP, CSCO, D, DUK, FB, GOOG, GOOGL, INTC, MSFT, NEE, SO, SPY, T, V, VZ, XLK, XLU
by: Canadian Dividend Growth Investor

Summary

Which sectors are too expensive for new investment dollars?

Verizon and AT&T still offer high yields at acceptable valuations.

Growth and income can be found at reasonable to discounted valuations within the technology sector in select large caps.

Fellow SA contributor, Fear & Greed Trader, shared in his recent article (a weekly update about S&P 500) two charts, which grabbed my attention in terms of indicating potential places to invest in the near future.

The first chart indicates where new money has gone (or exited) in the first half of the year.

Click to enlarge

Indeed, year-to-date, the Utilities ETF (NYSEARCA:XLU) has appreciated 21% and the big two telecoms have also appreciated more than 20%. Those are amazing returns especially including the above-average dividend yields utilities and telecoms typically offer.

Source: Google Finance

However, with the bid up prices, it has become riskier to invest in utilities and telecoms.

I'll use the top five utilities (based on index weight) in the XLU as examples.

NextEra Energy Inc (NYSE:NEE)

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NextEra trades at a way too expensive multiple as shown by the great distance between its price (black line) and its normal P/E (blue line). It trades at 21.8x earnings, while it normally trades at a multiple of 15.4.

Additionally, consensus analyst estimates its earnings per share [EPS] to grow at a rate of 6.7%, which aligns with the low-end of its annual historical growth rate.

Although NextEra has steadily and consistently increased earnings over time, its shares are too expensive today. New money invested into NextEra Energy today are set up to underperform because the market has irrationally bid up its shares.

Duke Energy Corp (NYSE:DUK)

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Duke trades at 18.8x earnings, while it normally trades at 15.4x its earnings. So, there's no margin of safety to invest in Duke today.

However, Duke offers an above average yield of 3.84%, which is 1.8x what the market (SPDR S&P 500 ETF Trust (NYSEARCA:SPY)) offers (a yield of 2.06%). So, investors who are already invested in it might still hold it for the stable income.

Consensus analyst estimates have its EPS growing at a rate of 4.8%.

Southern Co (NYSE:SO)

Click to enlargeSouthern trades at 18.9x earnings while it normally trades at 16.3x. So, there's no margin of safety for investing in this utility today.

However, Southern offers an above average yield of 4.14%, which is 2x that of what the market offers. So, investors who are already invested in it might still hold it for the stable income. Consensus analyst estimates have its EPS growing at a rate of 4.5%.

Dominion Resources, Inc. (NYSE:D)

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Dominion has been trading sideways since April 2014. Its share price has amazingly remained stubbornly strong even though it has been overvalued for an extended period of time. Its price action indicates it's a strong company. However, its earnings are still playing catch up.

Trading at 21.6 times earnings, there's no margin of safety to invest in Dominion today.

However, Dominion offers an above average yield of 3.58%, which is 1.5x that of what the market offers. So, investors who are already invested in it might still hold it for the stable income. Consensus analyst estimates its EPS to grow at a rate of 6.1%.

American Electric Power Company Inc (NYSE:AEP)

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American Electric Power trades at 19.2x earnings, while it normally trades at 13.5x its earnings. So, its shares are way too expensive. Additionally, consensus analyst estimates its EPS to grow at a rate of 4.6%, which doesn't particularly stand out from the group.

Click to enlarge

If its multiple reverts to the mean within the next 1.5 years, we're looking at an annualized negative return of at least 7.6%.

Reversion to the mean can happen for any of these companies that are overvalued, and it could mean negative returns in the short term.

What about the telecoms?

AT&T Inc. (NYSE:T)

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Trading at 15.3x its earnings, AT&T looks fully valued. With the consensus analyst estimated EPS growth rate of 5.2%, AT&T is priced at a better value than the utilities and offers a higher yield of 4.5%.

Verizon Communications Inc. (NYSE:VZ)

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Trading at 14.2x its earnings, Verizon looks a bit undervalued. However, its consensus analyst estimated EPS growth rate of 4.6% is about 60 basis points lower than AT&T. So, it makes sense that it trades at a slightly lower multiple than AT&T.

At best, the telecoms are fairly valued. However, if you're looking for a safe and above-average income at a reasonable valuation, the telecoms are a better choice than the utilities currently.

Where are the best values?

As shown in Fear & Greed Trader's first chart, in the first half of the year, money outflows occurred in the Technology, Consumer Discretionary, Health Care, and Financials.

Fear & Greed Trader's comment for the chart below was, "Tech continues to have the best 'beat' rate in the last 15 years. Consumer Discretionary follows and the growth laden Healthcare sector has fared well also."

Click to enlarge

Source: Bespoke

With that said, Technology is a good sector to start looking for value today. The Technology ETF's (NYSEARCA:XLK) top 10 holdings include AT&T and Verizon. Both classes of the Alphabet Inc (NASDAQ:GOOGL) (NASDAQ:GOOG) shares are there as well. I'll only include the GOOG graph below as both are similar.

Apple Inc. (NASDAQ:AAPL)

At under $97 per share, Apple trades at 11.4 times its earnings. Since the consensus analyst estimates EPS growth to be 9.9%, Apple is priced at a good value. Its 2.4% yield is safe and its dividend is growing as well.

Microsoft Corporation (NASDAQ:MSFT)

At about $52 per share, Microsoft trades at 19.6 times its earnings. Its consensus analyst estimated EPS growth is 10.8%.

Microsoft's S&P credit rating is AAA, the highest possible rating, showcases Microsoft's financial strength and quality. So, Microsoft shares may be worth the premium multiple. It also offers a safe yield of 2.75% that should continue to grow from dividend increases.

Facebook Inc (NASDAQ:FB)

Facebook has been an amazing total returns story so far, despite being overvalued at its IPO in 2012. It was trading at roughly $40 per share at IPO and fell to below $20 soon after.

It didn't take long before Facebook proved itself by growing its earnings at an extraordinary rate. Its EPS increased at an annualized rate of 42% between 2012 and 2015.

It looks like the company can continue growing at a rate of 30% as the consensus analyst estimated EPS growth is 32.4% for the next three to five years. As long as it can maintain that growth rate, its multiple of 39.4 is reasonable.

Alphabet

Alphabet trades at a multiple of 22.3, and the consensus analyst estimated EPS growth is 16.7%. So, at about $706 per share, Alphabet trades in fair value range.

Intel Corporation (NASDAQ:INTC)

Intel Corporation fundamental analysis graph Click to enlarge

Trading at 14.4x its earnings, Intel is reasonably valued. Its consensus analyst estimated EPS growth rate is 9.6%, which is above average. Its dividend yield of 3.06% is well covered by its earnings.

Cisco Systems, Inc. (NASDAQ:CSCO)

Cisco Systems fundamental analysis graph Click to enlarge

Trading at 12.6x its earnings, Cisco trades below a multiple of 15, which makes it undervalued. Its consensus analyst estimated EPS growth rate is 7.3%. Additionally, its dividend yield of 3.55% is well covered by a payout ratio of about 45%.

Visa Inc (NYSE:V)

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Out of the group, Visa looks the most expensive for its anticipated growth rate. It trades at close to 28x its earnings and its consensus analyst estimated EPS growth rate is 16.8%.

It's not an apples-to-apples comparison, but Alphabet is estimated to have similar growth - yet it trades at only 22.3x its earnings.

Summary & Conclusion

The utilities are generally overvalued, and investors should exercise extra caution if they are investing new money in the sector.

Although Verizon and AT&T have appreciated more than 20% year-to-date, they're still reasonably valued and offer safe yields of 4-4.5%.

In the Technology sector, both income and growth can be found at a value. If you're looking for income, Intel and Cisco both offer yields of above 3% at reasonable to discounted valuations. If you're looking for growth, Facebook and Alphabet look promising.

Microsoft doesn't look particularly expensive for the kind of quality it offers. On the other hand, Apple has been transforming from a growth company to a value company. It's priced at a discount at a multiple of 11.4 with reasonable growth expectations of 9.9%. Both Microsoft and Apple offer yields of 2.3% or higher.

Up next

Since this article is getting long, I'm going to discuss the sectors of Consumer Discretionary, Health Care, and Financials in future articles.

Share your thoughts in the comments below

  • Which sectors/companies are you buying today?

  • Which sectors/companies are you avoiding from buying today?

  • Are you selling any shares from any sectors/companies due to overvaluation?

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Disclaimer: This article consists of my opinions and is for educational purposes only. Please do your own research and due diligence and consult a financial advisor and or tax professional if necessary before making any investment decisions.

Disclosure: I am/we are long AAPL, FB.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.