Utility stocks were the fashionable trade of 2011, with the broad-based Utilities Select Sector SPDR (XLU) racking up 14% gains vs. a down market. In 2012, however, utility stocks underperformed significantly, with the XLU fund posting a small loss in the calendar year vs. double-digit gain for the S&P 500.
So are utility stocks back in favor this year? You might think so given the only modest underperformance in January -- the XLU is up 4.3% YTD as of this writing vs. 5.9% for the S&P.
Unfortunately, the sector is grossly overvalued as a whole. According to WSJ Market Data, the Dow’s Utility Index is running hot at a trailing 12-month price-to-earnings ratio of 22.2 -- up dramatically from 14.4 at this time last year.
You might quibble over whether the market in general commands a higher P/E right now based on macro issues or whether individual stocks like Amazon.com (AMZN) still can be a good investment at nosebleed valuations. However, utilities are inherently low-growth stocks with modest historical P/E’s, and there’s no excuse for this kind of premium.
Many things go into stock selection, and I don’t mean to discount the long-term potential of these stocks -- particularly if you have a good cost basis and a robust dividend yield. But these specific picks in the utility sector should be setting off warning bells based on their overpriced valuations:
Southern Company (SO) has a modest trailing P/E of 16.2 and a forward P/E just south of 15 right now, but more importantly, it boasts an inflated five-year PEG ratio of 3.3 thanks to a mere 2% in projected earnings growth for fiscal 2013. The company also trades for twice its book value. The most recent analyst rating on the stock is a “hold” from Deutsche Bank on Jan. 31 with a $45 target -- a measly 3% upside from here -- which was reduced from a previous target of $46 that was only slightly less disappointing. Barclays had a similar message on Jan. 31 with an “equal weight” recommendation, reducing its price target from $48 to $46.