VPU: Utilities Dashboard For March

Summary

• Gas utilities are undervalued by 7% relative to 11-year averages.
• Water utilities are overvalued by 20% regarding the same metrics.
• Vanguard Utilities ETF: an alternative to XLU.
• 10 utilities stocks cheaper than their peers in March.
• Quantitative Risk & Value members get exclusive access to our real-world portfolio. See all our investments here »

Pgiam/E+ via Getty Images

This monthly article series shows a dashboard with aggregate industry metrics in utilities. It is also a top-down analysis of sector exchange-traded funds, or ETFs, like the Utilities Select Sector SPDR ETF (XLU) and the Vanguard Utilities ETF (NYSEARCA:VPU), whose largest holdings are used to calculate these metrics.

Shortcut

The next two paragraphs in italic describe the dashboard methodology. They are necessary for new readers to understand the metrics. If you are used to this series or if you are short of time, you can skip them and go to the charts.

Base Metrics

I calculate the median value of five fundamental ratios for each industry: Earnings Yield ("EY"), Sales Yield ("SY"), Free Cash Flow Yield ("FY"), Return on Equity ("ROE"), Gross Margin ("GM"). The reference universe includes large companies in the U.S. stock market. The five base metrics are calculated on trailing 12 months. For all of them, higher is better. EY, SY and FY are medians of the inverse of Price/Earnings, Price/Sales and Price/Free Cash Flow. They are better for statistical studies than price-to-something ratios, which are unusable or non available when the "something" is close to zero or negative (for example, companies with negative earnings). I also look at two momentum metrics for each group: the median monthly return (RetM) and the median annual return (RetY).

I prefer medians to averages because a median splits a set in a good half and a bad half. A capital-weighted average is skewed by extreme values and the largest companies. My metrics are designed for stock-picking rather than index investing.

Value and Quality Scores

I calculate historical baselines for all metrics. They are noted respectively EYh, SYh, FYh, ROEh, GMh, and they are calculated as the averages on a look-back period of 11 years. For example, the value of EYh for hardware in the table below is the 11-year average of the median Earnings Yield in hardware companies.

The Value Score ("VS") is defined as the average difference in % between two valuation ratios (EY, SY) and their baselines (EYh, SYh). FY is reported for consistency with other sector dashboards, but it is ignored in utilities' score to avoid some inconsistencies. The same way, the Quality Score ("QS") is the average difference between the two quality ratios (ROE, GM) and their baselines (ROEh, GMh).

The scores are in percentage points. VS may be interpreted as the percentage of undervaluation or overvaluation relative to the baseline (positive is good, negative is bad). This interpretation must be taken with caution: the baseline is an arbitrary reference, not a supposed fair value. The formula assumes that the two valuation ratios are of equal importance.

Current Data

The next table shows the metrics and scores as of last week's closing. Columns stand for all the data named and defined above.

	VS	QS	EY	SY	FY	ROE	GM	EYh	SYh	FYh	ROEh	GMh	RetM	RetY
Gas	7.41	0.22	0.0581	0.5750	-0.0824	9.54	36.49	0.0478	0.6165	-0.0617	9.38	36.98	-1.19%	-2.49%
Water	-20.03	2.29	0.0327	0.1779	-0.0525	10.15	55.23	0.0370	0.2486	-0.0319	9.67	55.43	-7.09%	2.89%
Electricity and Multi	-7.58	-8.83	0.0511	0.4434	-0.0874	8.22	38.12	0.0514	0.5191	-0.0472	9.80	38.71	0.06%	-0.89%

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Value and Quality chart

The next chart plots the Value and Quality Scores by industry. Higher is better.

Value and Quality in utilities (Chart: author; data: Portfolio123)

Evolution Since Last Month

Value scores have improved in all subsectors.

Variations in value and Quality (Chart: author; data: Portfolio123)

Momentum

The next chart plots median returns by subsector.

Momentum in utilities (Chart: author; data: Portfolio123)

Interpretation

Gas utilities are undervalued by 7% relative to 11-year averages, and they show a quality score close to the historical baseline. Electricity and multi utilities are slightly overvalued and below their quality baseline. Water utilities are the less attractive subsector, with a 20% overvaluation regarding the same metrics. However, their quality score is just above to the baseline.

Focus on VPU

The Vanguard Utilities ETF (VPU) has been tracking the MSCI USA IMI Utilities 25/50 Index since 01/26/2004. The expense ratio of 0.10% is the same as XLU, and a bit more expensive than Fidelity MSCI Utilities Index ETF (FUTY) (0.08%), which tracks the same index. VPU is also available as a mutual fund (VUIAX).

As of writing, it has 64 holdings. The next table shows the top 10 names with fundamental ratios and dividend yields. The portfolio is quite concentrated: their aggregate weight is 52.6%.

Ticker	Name	Weight	EPS growth %TTM	P/E TTM	P/E fwd	Yield%
NEE	NextEra Energy, Inc.	13.30%	15.47	36.46	24.53	2.45
DUK	Duke Energy Corp.	6.84%	-32.68	29.20	17.23	4.14
SO	The Southern Co.	6.47%	45.08	20.82	18.87	3.99
SRE	Sempra Energy	4.44%	61.41	22.47	16.60	3.20
D	Dominion Energy, Inc.	4.37%	-73.06	52.11	13.47	4.78
AEP	American Electric Power Co., Inc.	4.26%	-9.31	20.47	17.40	3.61
EXC	Exelon Corp.	3.78%	26.26	19.18	17.83	3.42
XEL	Xcel Energy, Inc.	3.33%	7.19	21.19	19.92	3.09
ED	Consolidated Edison, Inc.	2.99%	21.29	20.63	19.83	3.36
PEG	Public Service Enterprise Group, Inc.	2.84%	258.58	28.70	17.24	3.85

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The performance and risk metrics of VPU and XLU since February 2004 are almost identical (see table below).

	Total Return	Annual. Return	Drawdown	Sharpe ratio	Volatility
VPU	457.22%	9.40%	-46.31%	0.61	13.89%
XLU	456.46%	9.39%	-46.48%	0.6	14.16%

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Data calculated with Portfolio123

In summary, Vanguard Utilities ETF is a good ETF for investors seeking a capital-weighted exposure in utilities. It is more diversified than XLU (64 holdings vs. 32), but it has made no difference in historical performance. XLU is a better instrument for tactical allocation and swing trading thanks to much higher trading volumes. Exposure to the top names is high, especially to NextEra Energy. Investors seeking a more balanced portfolio in this sector may prefer the Invesco S&P 500 Equal Weight Utilities ETF (RYU).

Dashboard List

I use the first table to calculate value and quality scores. It may also be used in a stock-picking process to check how companies stand among their peers. For example, the EY column tells us that an electricity company with an Earnings Yield above 0.0511 (or price/earnings below 19.57) is in the better half of the industry regarding this metric. A Dashboard List is sent every month to Quantitative Risk & Value subscribers with the most profitable companies standing in the better half among their peers regarding the three valuation metrics at the same time. The list below was sent to subscribers several weeks ago based on data available at this time.

HE	Hawaiian Electric Industries, Inc.
BKH	Black Hills Corp.
PNW	Pinnacle West Capital Corp.
WTRG	Essential Utilities, Inc.
ETR	Entergy Corp.
NJR	New Jersey Resources Corp.
NI	NiSource, Inc.
NRG	NRG Energy, Inc.
CNP	CenterPoint Energy, Inc.
SR	Spire Inc.

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It is a rotational model with a statistical bias toward excess returns on the long-term, not the result of an analysis of each stock.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.