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Which Other Utilities Are In The Same Class As Southern Company?

A few days ago, I wrote an article on the reasons why I am still buying utility Southern Company (NYSE: SO ) and received an interesting comment. A reader asked what other utilities have the same quality attributes as SO: “Which other utilities are in the class of SO?” The most comprehensive answers is: It all depends. It depends on what criteria is being used to classify SO. Is it by S&P Quality Rating for 10-yr consistency in earnings and dividend growth? Is it by level of credit support offer by the governmental regulatory bodies? Is it by earnings yield, dividend yield, PEG ratio, ROIC, or some other fundamental comparison? Is it a combination of all the above? The criteria used should depend on the risk portfolio of the individual investor and on his/her goals and specific strategies to reach those goals. Let’s begin with arguably the easiest to research: S&P Equity Quality Rank. The Quality Rank groups companies based on their 10-yr consistency in earnings and dividend growth, with A+ being the highest and B+ considered average. Out of the 2,802 companies with equity ratings, only 2% fall into the top category and 10% are considered above average at A- and higher. A+ Highest 2.2%; 38 companies A High 2.9 %; 84 A- Above Avg. 5.6%; 159 B+ Average 16.8%; 473 B Below Avg 22.1%; 621 B- Lower 26.9%; 755 C Lowest 23.9%; 669 Most utilities are rated by S&P Capital IQ and their reports are readily available from most brokerage accounts. For example, I have access to a fidelity.com brokerage account offering a stock screener including the Quality Rankings as an option. Of the 137 utilities identified by S&P, 78 have an Equity Ranking; 3 are rated A+, 8 are rated A, and 19 are rated A-, with 48 rated B+ and lower. One of the criteria for a Ranking is a 10-yr trading history, and some utilities have recently restructured and have not achieved this minimum review period. Southern Company is rated A-. Below is a listing of utilities whose Quality Ranking is A- or higher: Sources: fidelity.com, S&P Capital IQ. Another criteria could be Return on Invested Capital. ROIC is a tool used for comparing management effectiveness. While many will look at return on equity or return on assets, ROIC is a more encompassing matrix as it calculates shareholder returns generated by management utilizing all the capital at its disposal – debt and equity. Using the 30 companies above, comparison of 3-yr average ROIC would look like the table below. However, ROIC is only half the equation as it is best to also calculate the weighted average cost of capital WACC to determine the net return, also know as the “hurdle rate”. While American Water Works (NYSE: AWR ) has the largest 3-yr average ROIC at 9.0% and Entergy (NYSE: ETR ) with the lowest at 5.1%, after deducting their WACC, AWR has a Net ROIC of 1.1% and ETR has a -0.2%. Of the above list, the best Net ROIC is generated by small-cap water utilities Artesian Resources (NASDAQ: ARTNA ) and Connecticut Water Service (NASDAQ: CTWS ) at 3.4% and 3.2% respectively. Southern Company at 2.2% outperforms most of its Electric and Multi-utility rivals except WEC Energy (NYSE: WEC ) and SCANA Corp (NYSE: SCG ). Sources: Guiding Mast Investments, Morningstar.com, thatswacc.com. It is important to note the average ROIC for the utility sector is between 4.0% and 4.5%, demonstrating the quality of the above list. Managers at the above listed companies outperformed the sector 3-year average on ROIC by between 20% and 100%. Another method to review utilities is by the regulatory environment in which they operate. Even as an inexact science, the relationship between a utility and the regulatory body controlling its profitability is an important consideration. As the regulatory environment is essential to developing credit ratings for utilities, S&P Credit has a three-level assessment of the regulatory environment by state. Published in 2014, the latest US Utility Regulatory Assessment rates the following states as being “Strong”, compared to “Strong/Adequate”, and “Adequate”: FERC, Wisconsin, Michigan, Iowa, Kentucky, Alabama, Florida, South Carolina, North Carolina, , and Colorado. Only Mississippi and Hawaii were listed as “Adequate” with the balance of the states falling in the middle. S&P believes these nine states and the Federal Energy Regulatory Commission offer improved support for the utilities under their jurisdiction. ITC Holdings (NYSE: ITC ), NextEra (NYSE: NEE ), WEC Energy , MGE Energy (NASDAQ: MGEE ), and SCANA have some of the same positive regulatory environments as Southern Company. Some investors are focused on the income attributes of utility stocks, and the current yield is an important consideration. Various industries within the sector usually offer comparable yields, with Electric utilities historically paying a higher yield and Water utilities offering a bit lighter income. On this basis, the top yielding stocks by industry are Entergy and Southern Company, South Jersey Industries (NYSE: SJI ) and Southwest Gas (NYSE: SWX ) (GAS is being purchased by SO), Avista (NYSE: AVA ) and SCANA , along with Artesian Resources and Middlesex Water (NASDAQ: MSEX ). The table below lists the recent yield by company as offered on Morningstar.com Source: Guiding Mast Investments, Morningstar.com, thatswacc.com. Some investors are looking for stocks that are undervalued, and many investors have their own definition of “undervalued”. One possible criterion could be the difference between the current PE ratio vs it historic PE ratio. Fastgraph.com offers their well-known above/below blue line visualization of this trend, with a black line representing current and a blue line representing a historic PE. The table below lists these stocks and their current relationship to historic PE ratios. For example, ITC is currently trading at a PE ratio of 18.8 when its historic PE is closer to 22.6, for a difference of -3.8. On the other end of the spectrum, the buyout is causing Piedmont Natural Gas (NYSE: PNY ) to trade at a PE of 30.6 vs historic levels of 18.2 for a difference of +12.4. Southern Company is currently trading at its long-term historic PE valuation, and those stocks listed above it in the table has similar, or better, attributes. While it is difficult to answer the original question of other utilities in the same “class” as Southern Company, the five attributes above should allow utility investors to begin their own comparison. Personally, of the list above, I would chose four companies of similar “stature” as Southern Company: ITC Holdings, SCANA Corp, Connecticut Water, and Entergy/NextEra (tie). Author’s Note: Please review disclosure in author’s profile.

S&P 500 Valuation Dashboard – December Update

Summary 5 key fundamental factors are calculated across sectors. They are compared to historical averages. It results in a value score and a quality score for each sector. This article is part of a monthly series giving a valuation by sector of companies in the S&P 500 index (NYSEARCA: SPY ). I follow some fundamental factors for every sector and compare them to historical averages, so as to create a synthetic dashboard with a Value Score (V-score) and a Quality Score (Q-score). The choice of the valuation ratios has been justified here . The Q-score uses the Return on Equity (see why here ). In this series you can find numbers that may be useful in a top-down approach. There is no individual stock analysis or recommendations. You can refine your research reading articles by industry experts here . Methodology The median value of 4 valuation ratios is calculated for S&P 500 companies in each sector: Price/Earnings (P/E), Forward Price Earning for the current year (Fwd P/E), Price to sales (P/S), Price to free cash flow (P/FCF). It is compared to its own historical average Avg. The difference is measured in percentage (%Hist). For example, %Hist= 10 means that the current median ratio is 10% overpriced relative to its historical average in the sector. The V-score of a sector is the average of %Hist for the 4 factors, multiplied by -1, so that the higher is the better. The Q-score is the difference between the current median ROE (return on equity) and its historical average. Why and how using median values Median values are simpler than capital-weighted averages or aggregate ratios on each sector considered a mega company. They are also better reference data than averages for stock-picking. Each number in the table below is the middle point of a sector data set, which can be used to separate the good elements and the bad ones for the sector and the factor. Median values are also less sensitive to outliers than averages. A note of caution: for ETF investors, the most relevant valuation ratio would be the result of an aggregate calculation, neither a median value nor a capital-weighted average of individual stock factors. Example The next chart shows an example: the median P/E for all S&P 500 companies (updated on the week of publication). (click to enlarge) The latest value is compared to the average of the reference period to calculate %Hist. Sector valuation table on 12/14/2015 The next table reports the median valuation ratios. For example, the P/E column gives the current median value of P/E in each sector. The next “Avg” column gives its average between January 1999 and August 2015, which is my arbitrary reference of fair valuation. The next “%Hist” column is the difference between the historical average and the current value, in percentage. So there are 3 columns relative to P/E, and also 3 for each ratio. The first column “V-score” shows the value score as defined above. V-score P/E Avg %Hist Fwd P/E Avg %Hist P/S Avg %Hist P/FCF Avg %Hist All -18.48 21.15 19.18 10.27 16.6 14.83 11.94 2.16 1.58 36.71 28.41 24.7 15.02 Cons.Disc. -19.48 20.07 18.7 7.33 15.99 14.56 9.82 1.61 1.12 43.75 27.52 23.52 17.01 Cons.Stap. -31.01 25.6 20.48 25.00 19.57 16.27 20.28 2.33 1.54 51.30 50.06 39.28 27.44 Energy -7.36 20.31 17.8 14.10 25.89 14.38 80.04 1.48 1.94 -23.71 18.05 30.59 -40.99 Financials -36.60 18.19 16.16 12.56 14.77 12.38 19.31 2.81 2.03 38.42 21.59 12.26 76.10 Healthcare -6.04 27.92 23.76 17.51 16.3 16.85 -3.26 3.38 2.93 15.36 28.41 30.04 -5.43 Industrials -10.82 18.66 18.75 -0.48 16.15 14.52 11.23 1.47 1.24 18.55 29.25 25.66 13.99 I.T. & Tel. 2.22 24.79 27.16 -8.73 16.47 19.29 -14.62 3.17 2.72 16.54 25.48 26.02 -2.08 Materials -19.35 22.41 19.74 13.53 16.92 14.36 17.83 1.37 1.15 19.13 34.94 27.53 26.92 Utilities -27.66 17.63 15.21 15.91 15.81 13.15 20.23 1.63 1.11 46.85 Energy: P/FCF Avg starts in 2000 – Utilities: P/FCF not taken into account because of frequent outliers in this sector. V-score chart Sector quality table The next table gives a score for each sector relative to its own historical average. Here, only one factor is accounted. Q-score (Diff) Median ROE Avg All -0.50 14.43 14.93 Cons.Disc. 3.99 21.33 17.34 Cons.Stap. -2.86 21.2 24.06 Energy -14.14 0.75 14.89 Financials -2.38 9.93 12.31 Healthcare -4.71 12.89 17.6 Industrials 2.90 19.85 16.95 I.T. & Tel. 1.88 14.99 13.11 Materials 4.85 18.74 13.89 Utilities -2.25 9.1 11.35 Q-score chart Interpretation The S&P 500 looks overpriced by about 18.5% relative to the historical reference period. Since last issue’s statistics (11/10): SPY is down by more than 2.5%. Overpricing has increased by about 1%. Quality is stable globally and for every sector. 4 sectors have improved in valuation: Energy, Consumer Discretionary, Consumer Staples and Industrials. The only attractive sector regarding these metrics is Technology (including Telecom). It looks underpriced and has a median ROE above the historical average. The least overpriced sector among the rest is Healthcare. The most overpriced sector is Financials. For Materials, Industrials and Consumer Discretionary, a quality factor better than the historical average can justify at least a part of the overpricing. If you want to stay informed of my updates on this topic and other articles, click the “Follow” tab at the top of this article. Data: portfolio123

Investing In A Turbulent Market

Summary In turbulent times, investors need a plan and stick with a few basic rules. Assess macro conditions to guide investment decisions. Recognize the fact that danger and opportunities usually go hand in hand. Actively tweak winning odds to our favor as frequently as we can. It’s been two months since I left my role as a systematic global macro manager to focus on a few equity strategies I have been developing over the past few years. The timing was not great as world equities have been in a tailspin. Many blame China, the US Federal Reserve, and anemic world economic growth as the causes of the selloff. To me, they are just excuses. The real culprit of the market downturn is the investor jitters. Disciplined investors should follow some basic principles for investing in a turbulent environment. Here are some rules I follow: 1. Assess macro conditions to guide investment decisions 2. Recognize the fact that danger and opportunities usually go hand in hand 3. Actively tweak winning odds to our favor as frequently as we can. Assessing Macro Conditions to Guide Investment Decisions An old saying “rising tide lifts all boats” has found new meaning in stocks since 2009. Central banks around the world injected trillions of dollars into the world financial system. Ample money supply is undeniably one of the most important reasons for the current equity bull market. An equity investor should have done well if he recognized this simple macro factor. Therefore, accurately assessing the global macro environment is instrumental in performance. Differing opinions of economic conditions are the root cause of investor anxiety. So where are we now? China, as the world economic growth engine for the last decade, is facing some headwinds. It needs to absorb the excess from multi-decade economic expansion, rein in speculation, transition its economy from low-cost manufacturing to service and consumption, and steady investments and long-term growth to a sustainable level. Such a transition is not going to be easy and painless at all times. As someone who grew up in China before the reform began in earnest, I often found investors not giving enough credit to the success of China’s economic policies that has elevated a poor country with food rationing to a world economic powerhouse. Over the past 20 years, there were many calls of hard landing in China by market “gurus,” but none materialized. There is a certain arrogance to those calls. Is China facing hard landing again this time? I doubt that! Just as we like to say in the West “quiet water runs deep,” people in the East like to say, “narrow water runs far.” Publicizing policies has never been a strong suit of running things in China. Nevertheless, I believe China has economic means and a deep bench of highly skilled policy makers to navigate choppy waters. Everyone can make mistakes, but so far, there is no indication that China won’t be successful again in turning the ship around this time. In my view, they are proactively using policy tools to minimize the negative impact in a changing world. Investors are fickle. Before the two-day US Federal Reserve policy meeting last week, futures market implied a 30% chance of an interest rate hike in September. The market was right, the Federal Reserve did not hike interest rates. At the same time, investors reacted poorly to the decision as the US dollar sold off and interest rates dropped immediately after the announcement. Was the decision a surprise or was it expected? Investors cannot make up their mind. In my view, the timing of the Fed rate hike is not that important. There is no urgency to a rate hike in the absence of inflationary pressures. Nevertheless, barring significant economic deterioration, we will get a rate hike in December. Otherwise, Chairman Yellen’s credibility will be at risk as she previously indicated a hike this year. Given that outlook, I suspect both US dollar and interest rates will trade higher in the next two months. Moreover, according to some studies, a 25 basis points hike will only roughly translate into a 0.1% decline in GDP growth. There is simply no reason to be fixated on that. Accurate macro assessments can not only help us achieve long-term profitability, but also guide our short-term trading. A number of recent selloffs in global equity markets were in sympathy to selloffs in the Chinese equity market. Given the Chinese National Day is coming on October 1, an imminent meltdown in China is almost impossible. Therefore, any significant selloff could create short-term buying opportunities. Recognize the Fact that Danger and Opportunities Usually Go Hand in Hand Novice investors tend to chase markets and hang on to losers too long. It is much better to pick up quality names in a down market when everyone else is selling. In addition, losers tend to go down less than quality names precisely because some investors cannot psychologically part with losers, and instead sell stocks with gains to raise funds during a market downturn. Do not be afraid of selling losers! Better yet, pick up some winners in a down drift by selling losers for harvesting capital losses to reduce realized capital gains. Furthermore, global economic conditions are getting better, not worse – Europe is finally getting ahead of its sovereign debt crisis, the US economic growth is intact, China is working out short-term pains for long-term gains, the weak energy price should largely be stimulative to growth, and global monetary policies will remain accommodative for the foreseeable future. Therefore, there are opportunities to be had in the current passing danger. Actively Tweak Winning Odds to Our Favor as Frequently as We Can I consider myself as a long-term investor as I look to profit from fundamental research and typically hold stocks for an extended period of time. Fundamentals never play out overnight. However, I question the effectiveness of the “buy, hold and do nothing” strategy in the current market environment where information is so readily available through the internet, media, and social networks, affecting investor psyche constantly, and generating market volatility. Because of daily marks to market, professional hedge fund managers cannot sit idle and do nothing during market turbulence. I would argue that individual investors who look after their own portfolios should also be actively looking for ways to increase winning odds by using available tools such as listed equity options. Here are a few suggestions: a. If one wants to buy 100 shares of stock XYZ, he can sell one contract of put option at a strike price lower than or close to the current stock price. At maturity, if the stock price is higher than the strike price, one gets to keep the put option premium; otherwise, one acquires the stock at a price lower than the current price. b. When a stock in a portfolio has appreciated significantly, one should consider selling some covered calls to lighten up the load. At maturity, if the stock price is higher than the strike price, one effectively sells the stock at the strike price plus option premium; otherwise, he gets to keep the option premium. c. In fact, instead of following the red-hot “dividend investing” strategy, a) and b) can be viewed as a “create-your-own-dividend” strategy on any stock. With weekly options, one can aim to generate 10% annual yield by selling options. That’s 10% income and/or cushion one doesn’t have if he does nothing. d. During a market downturn, instead of buying quality stocks outright, one can buy calendar spreads, i.e. buying long-term calls against selling short-term calls at appropriate strikes to further reduce risk. e. Shorting high beta, richly valued stocks can be a more effective hedge than shorting index futures in the portfolio. There are many strategies that can be deployed day in and day out to generate consistent returns or opportunistically in turbulence when everything is out of whack. But one should always have a plan to deal with different market conditions and follow a set of rules so that he is not caught off guard. Let me know what you think. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.