Utilities By The Book

By Gregory S. Davis | January 20, 2009 AAA

Utilities are not the gadget-producing tech companies of Silicon Valley, nor are they the power brokers embedded in the bedrock of Wall Street. Utilities are simply providers of the power that institutions and individuals use to work and live. The following utilities are currently trading near or below their book value, suggesting the possibility of a brighter future.

Below Book
Reliant Energy
(NYSE:RRI), Great Plains Energy (NYSE:GXP) and Duke Energy (NYSE:DUK) are geographically dispersed between Houston, Texas; Kansas City, Mo.; and Charlotte, N.C., respectively. What the three power generation companies have in common is a break-up value above their current stock price. In other words, each utility is currently trading at or below its book value, which could signal an undervalued stock.

Primer On Valuation
Valuing a stock can be carried out by technical or fundamental analysis. Technical analysis involves following the trend of a stock chart to discern the future direction of a stock, while the fundamental analysis approach relies on economic and quantitative factors to determine value. The problem arises when the stock of a financial juggernaut like Citigroup (NYSE:C) trades below $4 a share. Investors trying to make an accurate decision using either method may still come up scratching their heads given external changes like a slowing economy and internal hiccups that can plague any given corporation. (Read Blending Technical And Fundamental Analysis to find out how you can combine the best of both strategies to better understand the markets.)

Beta In Action
Even when fundamentals appear to be unreliable, investors should still consider the beta value assigned to each stock. Beta essentially measures a stock's volatility against a broad index like the S&P 500. A beta below "1" has less correlation to the overall market, while a beta above "1" suggests greater volatility. Using the beta test for the utilities reveals beta values below "1" for Duke Energy and Great Plains Energy, along with a beta of "2" for Reliant Energy. Over the past 12 months Reliant stock has fallen more than 70%, illustrating the volatility of a stock with a high beta. During the same time period, Great Plains Energy fell 27% with a beta of 0.7 while Duke Energy fell less than 16% with a beta of 0.5. (Learn more about using this tool by reading our Beta: Gauging Price Fluctations.)

Final Thoughts
Book value and beta alone are still not sufficient to determine the future direction of any of the utilities mentioned; or any other stock, for that matter. An approach investors can rely on is to first identify a company whose services or products have a current and future need, and adopt a dollar-cost-averaging approach to gain exposure to the investment without having to be 100% accurate on the technical or fundamental sides of the equation.

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