Given investors' fondness for anything with a yield, utility stocks have seen their star shine over the last few years. Broad-based measures like the Utilities Select Sector SPDR (NYSE:XLU) have seen assets under management swell and now sit closer to their 52-week highs. However, given utilities' recent surge upwards, many analysts now believe much of the capital appreciation is baked into share prices. While the sector's high dividends (3.92% in the case of SPDR ETF) are certainly appealing, utility investors might find themselves falling behind, as the market continues to rally upwards. But not all is lost. The stable boring world of providing electricity, gas and water to customers does have several growth prospects. For investors, adding a dose of these "spicy" utilities could be what a portfolio needs.
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Overpriced After a Great Year
As increasing volatility and ultra-low interest became the norm during 2011, utility stocks became a port in the storm. Not including dividends, the Dow Jones Utility Index produced a 13.4% return through the past 12 months, as investors embraced the plodding sector. However, that outperformance is most likely over. Utilities are now in historically unfamiliar territory and currently trade at hefty premiums to the overall market. The previously mentioned Utility SPDR ETF can be had for a P/E of 14. The broader SPDR S&P 500 (ARCA:SPY) is currently going for a P/E 13. Historically, utilities have traded at a significant 26% discount to the broad market. (For related reading, see How To Use The P/E Ratio And PEG To Tell A Stock's Future.)
Likewise, as many electric companies have operated in regulated markets, PEG ratios have often been muted. However, as investors clamored for safety, many stocks within the sector are inflated with astronomical PEG ratios. For example, mega-utility Duke Energy (NYSE:DUK) currently has a PEG of 4.03.
Nonetheless, not all is lost for investors in the sector. The key for portfolios is finding those firms with more to offer than just a regular dividend. Varieties of utilities have actually begun to transform themselves into engines of growth. Grid upgrades and new additions into renewable energy sources are giving the many old stodgy power producers a new image. Smart meter roll-outs, along with demand response applications are moving firms into the realm of high-tech, leaving behind any "window and orphan" monikers. By betting on these firms, with justifiable metrics, portfolios have the ability to collect high dividends, but still see some real growth prospects in the years ahead.
Adding Some Spice to a Power Portfolio
While more traditional utilities would make decent additions to a growing portfolio, growth-oriented investors may want to look at the First Trust Utilities AlphaDEX (ARCA:FXU). The ETF implements a quant-based strategy that looks at growth factors, including three, six and 12-month price appreciation, sales to price and one year sales growth. The ETF also then looks at value metrics, such as book value to price, cash flow to price and return on assets. The Fund then kicks out the losers and creates a strong growth-tilted portfolio. Current top holdings include NRG Energy (NYSE:NRG) and Energen (NYSE:EGN). Expenses aren't cheap at 0.70%, but it does offer utility investors a chance for growth.
For investors looking for an individual choice, NextEra Energy (NYSE:NEE) could be a top pick. Over the last few years, it has transformed itself into a renewable energy powerhouse. The company is already one of the largest producers of solar and wind energy in the nation, but continues to grow that position. NextEra recently purchased two Ontario-based solar plants, totaling 40 MW from First Solar (Nasdaq:FSLR) and is spending $9 billion over the next few years to upgrade its grid. Shares of the growth utility currently yield 4.0%.
The Bottom Line
With the utility sector posting big gains in 2011, many analysts now believe underperformance is on the horizon. For investors, betting on the growth-oriented utility firms could alleviate this fact. Nuclear power-focused, Exelon (NYSE:EXC), along with the previous picks, make ideal selections for utility growth.
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At the time of writing, Aaron Levitt did not own shares in any of the companies mentioned in this article.