The Utilities sector ranks tenth out of the ten sectors as detailed in my Sector Rankings for ETFs and Mutual Funds report. It gets my Very Dangerous rating, which is based on aggregation of ratings of 9 ETFs and 33 mutual funds in the Utilities sector as of April 9, 2014. Prior reports on the best & worst ETFs and mutual funds in every sector are here.
Figure 1 ranks from best to worst the seven Utilities ETFs that meet our liquidity standards and Figure 2 shows the five best and worst-rated Utilities mutual funds. Not all Utilities sector ETFs and mutual funds are created the same. The number of holdings varies widely (from 21 to 78), which creates drastically different investment implications and ratings. The best ETFs and mutual funds allocate more value to Attractive-or-better-rated stocks than the worst ETFs and mutual funds, which allocate too much value to Neutral-or-worse-rated stocks.
To identify the best and avoid the worst ETFs and mutual funds within the Utilities sector, investors need a predictive rating based on (1) stocks ratings of the holdings and (2) the all-in expenses of each ETF and mutual fund. Investors need not rely on backward-looking ratings. My fund rating methodology is detailed here.
Investors should not buy any Utilities ETFs or mutual funds because none get an Attractive-or-better rating. If you must have exposure to this sector, you should buy a basket of Attractive-or-better rated stocks and avoid paying undeserved fund fees. Active management has a long history of not paying off.
Figure 1: ETFs with the Best & Worst Ratings
Sources: New Constructs, LLC and company filings
PowerShares DWA Utilities Momentum (PUI) and Fidelity MSCI Utilities Index ETF (FUTY) are excluded from Figure 1 because their total net assets (TNA) are below $100 million and do not meet our liquidity standards.
Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5
Sources: New Constructs, LLC and company filings
Meeder Funds: Meeder Utilities & Infrastructure Fund (FLRUX) is excluded from Figure 2 because its total net assets (TNA) are below $100 million and do not meet our liquidity standards.
Vanguard Utilities ETF (VPU) is my top-rated Utilities ETF and Fidelity Devonshire Trust: Fidelity Telecom & Utilities Fund (FIUIX) is my top-rated Utilities mutual fund. VPU earns my Very Dangerous rating and FIUIX earns my Dangerous rating.
PowerShares S&P SmallCap Utilities Portfolio (PSCU) is my worst-rated Utilities ETF and Rydex Series Funds: Utilities Fund (RYUTX) is my worst-rated Utilities mutual fund. Both earn my Very Dangerous rating.
Figure 3 shows that 11 out of the 135 stocks (over 4% of the market value) in Utilities ETFs and mutual funds get an Attractive-or-better rating. However, 0 out of 9 Utilities ETFs and 0 out of 33 Utilities mutual funds get an Attractive-or-better rating.
The takeaways are: mutual fund managers allocate too much capital to low-quality stocks and Utilities ETFs hold poor quality stocks.
Figure 3: Utilities Sector Landscape For ETFs, Mutual Funds & Stocks
Investors need to tread carefully when considering Utilities ETFs and mutual funds, as no ETFs and mutual funds in the Utilities sector allocate enough value to Attractive-or-better-rated stocks to earn an Attractive rating. Investors should look at individual stocks for exposure to this sector.
Consolidated Edison, Inc. (ED) is one of my favorite stocks held by Utilities ETFs and mutual funds and earns my Attractive rating. ED has grown after-tax profits (NOPAT) by 11% compounded annually over the last nine years. The company currently has a return on invested capital (ROIC) of 5%, which ranks second out of 22 multi-utility companies we cover. Despite the impressive profit growth, the company’s stock is down over 10% in the past year, which makes ED significantly undervalued. At its current valuation of ~$55/share, ED has a price to economic book value (PEBV) ratio of 0.7. This ratio implies that the market expects ED’s NOPAT to permanently decline by 30%. Consistent profit growth and pessimistic market expectations create a good investment opportunity in ED.
Northwest Natural Gas Company (NWN) is one of my least favorite stocks held by Utilities ETFs and mutual funds and earns my Very Dangerous rating. Over the past seven years, NWN’s NOPAT has declined by 1% compounded annually. Its ROIC has steadily declined every year to a bottom quintile return of 3% in 2013. On top of this, NWN has not generated positive economic earnings in any of the past 16 years. To justify its current valuation of ~$44/share, NWN would have to grow NOPAT by 5% compounded annually for the next 22 years. While 5% growth may not seem like such a high bar, we’re talking about a utility company with a track record of declining profits. The market’s growth expectations contradict the actual performance of the company. NWN is overvalued, and investors should stay away.
82 stocks of the 3000+ I cover are classified as Utilities stocks.
Figures 4 and 5 show the rating landscape of all Utilities ETFs and mutual funds.
My Sector Rankings for ETFs and Mutual Funds report ranks all sectors and highlights those that offer the best investments.
Figure 4: Separating the Best ETFs From the Worst ETFs
Figure 5: Separating the Best Mutual Funds From the Worst Mutual Funds
Review my full list of ratings and rankings along with reports on all 9 ETFs and 33 mutual funds in the Utilities sector.
Kyle Guske II contributed to this report.
Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector or theme.