All-Time High for the DJUA

A lot of market technicians are in a tizzy because the Dow Jones Utility Average just hit an all-time high. In fact, Richard Russell, who is a follower of the Dow Theory, has moved from the bearish camp to the neutral camp. That may not sound like a big deal, but to a loooong-time bear like Russell, it’s an act of major significance.

Mark Hulbert notes the reason for Russell’s change in outlook.

The first thing is the new all-time high in the Dow Jones Utility Average. According to Russell, “Normally, the Utility Average will hit its highs well before the final high in a bull market, although there have been times when the Utility Average topped out simultaneously with the bull market high.”

I think the market may move higher, but it won’t have much to do with the Dow Utility Average. The problem is that many public utilities have been too boring for too long. When some companies tried to break into new businesses, the results were a disaster. The whole industry tanked a few years ago thanks to headlines from the likes of Calpine and Enron. At one point in 2002, the Dow Utility Average was just 36% above its September high—its September 1929 high.

The good news is that many public utility are very sounds financially. They have strong balance sheet, and most importantly, lots of free cash flow. Since taxes were cut on dividends, utilities have become popular with income investors. Also, the recent Energy Bill loosens some of the heavy handed regulations. For example, the bill eliminates the Public Utility Holding Company Act of 1935 which makes mergers very difficult. The utilities sector has many good smaller companies that are being eyed by larger utes. Even Warren Buffett’s is getting in the act. I wouldn’t be surprised to see a large bank pick up a small utility.

Except for AES, none of the 15 stocks in the Dow Utility Average is expected to grow faster than the market over the next five years. Here are all stocks in the Dow Utility Average and Wall Street’s estimate for earnings growth over the next five years.
AES CP 18.0%
CENTERPOINT ENERGY 9.0%
TXU CORP 7.0%
EDISON INTL 6.5%
WILLIAMS COS 6.5%
EXELON 5.5%
DOMINION RES 5.0%
DUKE ENERGY 5.0%
PG&E 5.0%
SOUTHERN CO 5.0%
FIRSTENERGY 4.5%
PUB ENTRPR GP 4.0%
NISOURCE INC 3.5%
AMER ELECTRIC POWER 3.0%
CONS EDISON 3.0%

Here’s a chart of the Dow Utility Average going back to 1970.

You can see that the index is just above the high it hit four years ago. Although the index has grown steadily over the years, it has badly lagged the rest of the market, even adjusting for dividends. At some point, utilities may become attractive, but right now, I’d avoid the sector.

Posted by Eddy Elfenbein on September 9th, 2005 at 9:39 am

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