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Our last blog discussed safe harbors amidst the current storm of market volatility.  The idea presented was to investigate the strong buy stocks with the lowest betas.  This week we home in on a sector that is typically low volatility and low growth.  However, right now, we find fairly competitive earnings growth in this sector.

The Utilities industry in the United States is a cornerstone of economic stability and growth, providing essential services such as electricity, gas, and water to millions of consumers. This report focuses on six notable US domiciled stocks in the Utilities sector, identified by their ticker symbols: XEL, D, NEE, UGI, AEP, and AWK. All are rated as 5 (Strong Buy) by ValuEngine’s predictive model. 

I include a brief synopsis of the predictive model’s methodology for the uninitiated. The model uses proprietary algorithms that incorporate financial metrics such as earnings, forward estimates, interest rate forecasts, revenue growth, profit margins, and return on equity to assess stock performance.  The methodology emphasizes fundamental analysis, examining key financial statements, industry trends, and company-specific factors to determine intrinsic value.  Stocks are compared within their industry peers to ValuEngine also factors in risk assessment, considering market volatility, economic conditions, and company-specific risks to provide a comprehensive evaluation. evaluate relative performance and identify potential investment opportunities.  Those relative opportunities are characterized by our ratings which range from 1 (Strong Sell) to 5 (Strong Buy).

We take a bottom-up approach to sector evaluation to create our Sector Report.  Besides low beta and high dividend yield, another reason the Utilities Sector was chosen to be featured today is that it is currently the third highest sector in terms of current investment opportunity with a rating of 3.5 out of a possible 5. I note that historically the utilities sector is for income investors more than for investors looking for price appreciation.  Because of this, the sector has commonly been in the bottom half of forecast price gains.  There are a number of fundamental underpinnings of the industry which explains the unusual opportunities to derive income, superior return/risk ratios and top-quartile price gains from the sector.

The Utilities industry sector is undergoing a transformative phase characterized by several key trends:

• A significant shift towards renewable energy sources such as wind, solar, and hydroelectric power is reshaping the Utilities sector. This transition is driven by both regulatory mandates and consumer demand for cleaner energy.
• The adoption of smart grid technology, enhanced battery storage, and energy management systems is optimizing efficiency and reliability in energy distribution.
• Stringent environmental regulations and policies are compelling utilities to reduce carbon emissions and invest in sustainable infrastructure.
• There is a considerable focus on upgrading aging infrastructure to enhance resilience against natural disasters and improve service reliability.

The six 5-ratedcompanies under consideration—XEL, D, NEE, UGI, AEP, and AWK—are well-positioned to capitalize on these trends. In fact, excepting AWK, the rest can be thought of as energy technology companies.

Xcel Energy (XEL) is a leader in the renewable energy transition, with substantial investments in wind and solar power. The company's commitment to reducing carbon emissions and its innovative solutions make it a key player in the future of energy.

Dominion Energy (D) is at the forefront of infrastructure modernization, with significant projects aimed at enhancing grid reliability and expanding renewable energy capacity. The company’s strategic initiatives align technological trends.

NextEra Energy (NEE) is renowned for its aggressive expansion into renewable energy, particularly wind and solar power. Its extensive portfolio of clean energy projects positions it as a frontrunner in the Utilities sector's transformation.

UGI Corporation (UGI) focuses on natural gas distribution and energy services, with an emphasis on sustainability and energy efficiency. The company's diverse operations and commitment to innovation provide a solid foundation for growth.

American Electric Power (AEP) is heavily invested in upgrading its transmission infrastructure and expanding its renewable energy footprint. AEP’s initiatives are geared towards enhancing grid resilience and meeting evolving energy needs.

American Water Works (AWK) is the largest publicly traded water and wastewater utility company in the US. Its focus on infrastructure investment and regulatory compliance ensures the provision of high-quality water services.

The last three rows, analyzed in the aggregate, bolsters the investment thesis that the past 12 months has provided unusual opportunities for price appreciation for utilities.  All six utilities standard-bearers have outgained the S&P 500 ETF during the past 12 months.  Only NextEra, the only one of the six to have a negative return thus far in 2025, has underperformed on a Year-to-Date basis.  it is not surprising at all that all six stocks have dividend yields considerably higher than SPLG.  Dominion Energy’s 5.0% dividend yield is the highest of the group.   The returns forecast by the ValuEngine model follows the same pattern as what has been realized during the past 12 months.  The projected utility stock returns range from 14.1% to 16.7% as compared with just 4.9% expected from the S&P 500 ETF. Although all six utility stocks are rated strong buys, Xcel Energy (XEL) and Dominion Energy (D) are the two most attractive now.  Another plus for D is having an earnings growth rate of 23.6%, the highest in the study.

A similar picture is painted when moving on to ETFs. Given the unusual opportunities to invest for growth as well as income in the utilities Sector and six of its largest stocks, it may not be as surprising as it would have been normally to find that the three largest Exchange-Traded Funds (ETFs) in the Utilities sector also are rated 5 (Strong Buy).  As most regular readers of this blog probably know, I was an early pioneer of ETFs and generally recommend most investors that don’t consider themselves traders buy and hold ETFs in lieu of individual stocks,  ETFs offer diversified exposure to the industry with very low expense ratios, Accordingly, they have become the tools most commonly used to implement sector rotation strategies in attempts to take advantage of cyclical returns and risk-taking changes in the markets.

The six largest Utilities sector ETFs are: 

Utility Select Sector SPDR Fund ETF (XLU) is the largest and most popular Utilities sector ETFs, with substantial assets under management. It tracks the performance of the Utilities Select Sector Index, a market-cap-weighted index comprising a broad range of utility companies.

Vanguard Utilities ETF (VPU) follows the performance of the MSCI US Investable Market Utilities 25/50 Index, a larger and more diverse utilities index but is still market-cap weighted

Fidelity MSCI Utilities Index ETF (FUTY)  tracks the performance of the Dow Jones U.S. Utilities Index, providing broad exposure to the Utilities sector. Its holdings include a mix of electricity, gas, and water utilities. FUTY has the lowest expense ratio of the six ETFs at 0.08% (8 basis points, 1 basis point lower than XLU and VP.

iShares Utilities ETF (IDU) tracks the performance of the Dow Jones U.S. Utilities Index, providing broad exposure to the Utilities sector. Its holdings include a mix of electricity, gas, and water utilities. Its expense ratio is at least 30 points higher than that of the above three ETFs without attempting to find excess alpha or other value added.

First Trust Utilities AlphaDEX® Fund (FXU) seeks investment results that correspond generally to the price and yield, before fees and expenses, of an equity index called the StrataQuant® Utilities Index. This proprietary strategy index uses fundamental data relating to earnings strength and valuation to select and weigh the portfolio constituents. It has the highest expense ratio of the six ETFs at a whopping 0.64% (64 basis points).  Since it is value-added, the implicit aspiration is that FXU will deliver better performance that more than pays for the fee.

Virtus Reaves Utilities ETF (UTES) aims to provide total return through a combination of capital appreciation and income, primarily by investing in equity securities of companies in the utility sector, and is actively managed, not seeking to replicate a specific index. 

Once again, SPDR Portfolio S&P 500 ETF (SPLG) is used for comparisons.

ValuEngine’s ratings are consistent as 5 (Strong Buy) on all the utilities ETFs.  This is  not surprisingly in the NEE, D and AEP are held by all but one of them. So, how should an investor distinguish between them?

Clearly, when most investors, traders, managers and pundits discuss US utilities ETFs in a broad sense, XLU, the Utilities Select Sector SPDR is the first one that comes to mind.  It is more than twice as large as all the other ETFs in the study put together. It was also the first one. Its trading volume dwarfs the others put together considerably more, closer to ten times all the others put together.  Obviously, the vast majority of sector-timing trades using Utility Sector ETFs uses XLU. When it comes to net Fund Flows year-to-date, XLU also dominates this category. 

There are some investors, particularly some pension funds, which do prefer a broader universe for investing in utilities than restricting investment to only those utility stocks that made it into the S&P 500 Index.  Vanguard’s VPU and Fidelity’s FUTY were both created to serve that purpose, so similar that they use practically identical indexes.  FUTY has attempted to distinguish itself on price with an expense ratio that is one basis point lower than those of XLU and VPU.  Its negative fund flows year-to-date would tend to indicate that distinction has not been entirely successful in attracting assets. 

Since the first four ETFs are all attempting to capture and emulate utility sector performance without attempting superior performance, it makes sense that their returns and investment ratios are almost identical.  The question becomes whether the extra expense-ratio percentages paid to quantitatively managed FXU and UTES have been rewarded with disproportionately superior performance.

As a quant, I am somewhat surprised to report that the answer is yes.  FXU had superior performance to XLU and the other three in every period, outperforming by higher percentages than the differentials in their expense ratios. Moreover, actively managed UTES, managed by utility specialist Reeves as part of the Virtus Investments family, outperformed by an even greater amount during the past 1-, 3- and 5-year periods. It also seems to be a relative bargain to receive the benefits of its fully active management for 15 basis points less than the algorithmic management used for FXU.  There is an asterisk that must go with this statement that UTES is very clear about in its materials.  The active management team is focused on providing capital appreciation, not maximizing dividend income.  Therefore, UTES is not the best choice for income-focused investors.  Investors who choose ETFs for diversification may be more comfortable with VPU  or FUTY because UTES has just 23 different holdings. 

The bottom line is that with ratings of 5 (Strong Buy), all six ETFs are worthy of consideration. As long as the overall Utilities industry ETFs remains positive, the rest is up to individual preference and due diligence.  Driven by the growing demand for sustainable energy and infrastructure modernization and as utilities continue to adapt to regulatory changes and technological advancements, these ETFs are expected to benefit from the sector's long-term growth prospects.  Moreover, this area seems as if it could be one of the relatively safer areas of an economy where tariffs and trade wars are front and center.  Having the mandate to adjust prices with input costs is very helpful in such an environment.  Not being dependent upon export revenues also helps during such turbulence. 

The Utilities industry is at a pivotal juncture, with significant opportunities for growth and innovation. The six highlighted stocks—XEL, D, NEE, UGI, AEP, and AWK—are well-positioned to thrive in this evolving landscape. Using the ValuEngine Inc.’s methodology provides valuable insights into their potential performance. Additionally, the largest Utilities industry ETFs offer diversified exposure and are poised to benefit from the sector's positive outlook for 2025. As the industry continues to evolve, these investments present compelling opportunities for investors seeking stability and growth.

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