Utility stocks are in a strange place: They have barely managed to outperform the broader market since the beginning of the year, even as prices for electricity, gas and other services they offer have skyrocketed. There are certain reasons for that, but we don't necessarily have to avoid them just because everyone else is doing it.
Why haven't utilities done better?
Utility companies' revenues may have grown, but so have the costs of the raw materials they need. These extra expenses mean higher production costs and lower profit margins. And because utilities are highly regulated, they can't fully pass along those higher costs to customers. Their profits are often regulated, and governments regulate any profits above an “allowed profit” to subsidize customers. And with higher energy costs severely impacting consumers' disposable incomes (They represent 20% of household spending in some regions, up from 7% a year ago), investors can only hope that regulatory pressures continue to rise. In turn, high dividend yields and stable cash flows from utilities lead investors to treat them as if they were bonds, that is, as a fixed income asset. That makes utility stocks more vulnerable to rising interest rates and therefore less popular with today's investors.
So why do I want to have them in my wallet?路♂️
Utilities also have the best bond features. Unlike many other sectors that rely on a booming economy to grow their profits, utilities provide services that are always needed. This defensiveness tends to be valuable when the economy weakens. Additionally, these companies are typically heavily regulated with few competitors and predictable cash flows, meaning they can pay good dividends to investors. These two characteristics, resilience in economic downturns and stable income, help offset some of the damage caused by rising interest rates. But like stocks, utilities also have significant capital gains. And right now, there's good reason to believe they could be about to tap into that potential.
(i) Utilities are at the center of the green energy transition, as more polluting energy sources are phased out and greener sources are gradually introduced. The conflict initiated by Russia, the main gas supplier in Europe, has only accelerated that trend: European countries are focusing on improving energy efficiency and developing their own energy sources to reduce their dependence on external producers. Utilities have every incentive to invest in as many projects as they can, since their “allowed profits” are calculated as a margin of the assets they own. And since governments are trying to reduce their own countries' emissions, they have every incentive to help them without putting regulations in the way. We have to keep in mind that scaling up these renewable investments will take time – we may only be at the beginning of a great era for renewable energy.
(ii) Investors have been so pessimistic about the near-term prospects for utilities that they have likely put downward pressure on their valuations, with some of the highest quality utilities trading below 10 times their earnings. . This does not necessarily mean that it is cheaper than its long-term average, but we could say that it is not very expensive either. Sure there are still plenty of headwinds (regulation, commodity costs, rising interest rates) in the short term, but they won't stay around forever. And given the current pessimism, any positive surprise could start a significant rally.
And if we do not have training in financial investment, how can we take advantage of this opportunity?樂
Utilities may not give us the expected three-figure returns that some growth stocks provide in a bull market. But they are likely to outperform the broader market in a bearish environment, even if they cannot avoid losses entirely. And this could be exactly what our portfolio needs right now: an asset that will help our portfolios weather an economic downturn, guarantee us some income, and, if we're patient, offer us the potential for significant capital gains. As for where to invest, US utilities are sure to benefit from the trend, but the risk/reward balance looks quite attractive in Europe, where the transition to greener energy sources is accelerating and regulation is less of a challenge. If we don't have financial investment training And we don't want to screw up, gaining exposure with a diversified utilities ETF may be the safest and most viable options.
The iShares STOXX Europe 600 Utilities UCITS ETF is the best choice in Europe, and the Vanguard Utilities ETF (VPU) in the United States. The problem with ETFs is that they invest in all types of utilities, but those that focus on electricity and renewable energy are much more promising. Goldman Sachs has published a helpful list of its top picks for Europe:
From the entire list we can highlight three:
- Italian benchmark Enel has strong exposure to renewable energy and a high dividend yield of 6,3%, and its valuation appears low.
- Electricity supplier Engie is a solid company, with a high dividend yield of 7% and a low valuation.
- Solaris, which should directly benefit from the change in Europe's energy policy.