This weekend’s Barron’s had a large article on utility stocks and their current attractiveness. (see article here) A lot of the article discussed utilities and their relationship to bond yields. Yields have not moved up as much as investors expected over recent times, which has helped utilities be an outperformer in recent weeks. Another tailwind for utilities has been some defensive desire by investors with threats of a potential trade war looming.
While these are some positives for utilities, caution must still be taken when looking at the group. Here are two charts comparing the dividend yield of the XLU ETF and yields of BBB bonds and 10-year Treasuries.
The charts show BBB bond yields are the highest vs. utility yields in the last two years. You can also see that the spread between utility yields and the 10-year Treasury are as tight as they’ve been over the last two years. So when looking at yields alone, even though things have been positive, caution is still needed in the space.
Earnings are typically another big driver for utility stocks, and it is worth taking a look at the group along that metric. If you look at the P/E ratio of the XLU, you can see that it is below the average of the last two years, though the P/E has been rising over the last month and is quickly approaching the two-year average.
If you look at the XLU’s P/E over the last ten years the chart doesn’t look as encouraging.
Three utilities are mentioned in the article, AEP, XEL, and NEE. I thought I would include some historic charts to show how the valuation of these companies compares to their historical levels. NEE looks slightly expensive compared to its average P/E and dividend yield over the last two years, while AEP and XEL looks to be a bit on the cheaper side. But when looking at all three of these companies it is important to notice that their P/Es are above the level of the XLU, and that the dividend yield of both NEE and XEL are below the dividend yield of the XLU.