With the majority of the sectors (except Retail and Consumer Discretionary) on the verge of wrapping up their Q3 reporting cycle, the overall growth picture appears to be quite encouraging when compared to the past few earnings seasons. We note that the results of 63.3% of the utility stocks that have already reported position the sector in the top third of the 16 Zacks sectors in terms of year-over-year earnings growth.  

In fact, utilities have already recorded earnings growth of 15.9% compared with the S&P 500’s average year-over-year growth of just 1.6%. For Q3 as a whole, earnings for the utilities are expected to be up 13.8% on 5.3% higher revenues compared with 2.4% and 1.4%, respectively for the S&P 500 members.

In this context, it is imperative to mention that historically utility stocks have been a safe haven for risk-averse investors given the regulated nature of their business, the domestic orientation of the stocks that protect them from frequent currency fluctuations and the fact that the sector is a provider of basic services to the economy.

Moreover, utility stocks pay consistent dividends and steady price, which make them ideal for investment. According to USA Today, while the Dow Jones Industrial Average sank 7.9% in 2011, the Dow Jones Utility Average rose 5.6% over the same period (post the great depression).

Also, this sector is primarily a non-cyclical one and thus acts as a shield for investors during economic downturns. Maybe that’s why amid the widespread volatility that has been causing global sell-offs since last year, the Dow Jones Utility Average (DJU) improved12.9% in one year compared with the S&P 500’s return of just 0.89% over the same time frame.

Recent Factors Driving Utility Stocks

The recent changes in laws and regulations, including the U.S. Environmental Protection Agency’s (EPA) Clean Power Plan (CPP), requires states to reduce carbon dioxide (CO2) emissions from existing fossil fuel generators. As a result, renewable sources of energy like wind and solar power are gaining rapid popularity.

As per the latest report by the U.S. Energy Information Administration (EIA), published in Aug 2016, electricity generation from renewables is expected to increase 99% by 2030 and 152% by 2040 from 2015 level, under CPP requirements. Naturally, the latest trend in the Energy-Utility space involves companies transitioning their business from using coal-fired generators to renewable energy sources.

Moreover, the utility sector is also known for its capital-intensive nature. Because of this, utilities have been benefiting from the rock-bottom interest rate environment that is currently prevalent in the U.S. economy. With the U.S. presidential vote scheduled next week, the Fed has retained the present rate for now. However, talks hinting at a rate hike before the end of the year could hamper the growth momentum of the sector. Nevertheless, we expect the inherent strength of this sector to keep the momentum going.

The U.S. economy is also showing consistent signs of improvement with the unemployment rate coming down to 5% in Sep 2016 from 5.1% in Sep 2015. Moreover, the country’s real gross domestic product increased at an annual rate of 2.9% in the third quarter of 2016, as per estimates released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 1.4%.
We expect the aforementioned factors to strongly encourage investors to invest in utility stocks.

How to Pick the Right Stocks
 
Picking the right stock for your portfolio for assured returns could appear a daunting task given the wide range of companies in the utility space. One way to narrow down the list of choices is by looking at stocks that have a favorable Zacks Rank and a positive Earnings ESP.
Earnings ESP is our proprietary methodology for determining stocks with the best chance to surprise with their next earnings announcement. It shows the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate.
 
The combination of a favorable Zacks Rank – Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) – and a positive Earnings ESP is an indication of an earnings beat. Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as high as 70%. Please check our Earnings ESP Filter that enables you to find stocks that are expected to come out with earnings surprises.

For investors seeking to apply this strategy to their portfolio, we have highlighted three utility stocks that might surpass estimates this season.

Duke Energy Corporation (DUK - Free Report) : This Charlotte, the NC-based corporation is an electric and natural gas utility. Duke Energy has an Earnings ESP of +1.28%. That is because the Most Accurate estimate is $1.58 while the Zacks Consensus Estimate is pegged lower at $1.56.

The company holds a Zacks Rank #3 and is set to report third-quarter 2016 results before the opening bell on Nov 4.

The AES Corporation (AES - Free Report) : This Arlington, the VA-based company is a diversified power generation and utility.  AES Corp. has an Earnings ESP of +3.13% as the Most Accurate estimate is at 33 cents while the Zacks Consensus Estimate is pegged lower at 32 cents.

It has a Zacks Rank #3 and is set to release third-quarter 2016 results before the opening bell on Nov 4.

FirstEnergy Corp. (FE - Free Report) : This Arkon, the OH-based company generates, transmits, and distributes electricity. FirstEnergy has an Earnings ESP of +2.63%. While the Most Accurate estimate stands at 78 cents, the Zacks Consensus Estimate is pegged lower at 76 cents.

It has a Zacks Rank #3 and is set to release third-quarter 2016 results before the opening bell on Nov 4.

Pattern Energy Group Inc. (PEGI - Free Report) :This San Fransisco, CA-based corporation operates as an independent power provider. Pattern Energy has an Earnings ESP of +9.09%. That is because the Most Accurate estimate stands at a loss of 10 cents while the Zacks Consensus Estimate is pegged at a loss of 12 cents.

It has a Zacks Rank #2 and is set to release third-quarter 2016 results before the opening bell on Nov 7.

UGI Corporation (UGI  - Free Report) : This King of Prussia, PA-based corporation distributes, stores, transports, and markets energy products and related services. It has an Earnings ESP of +20.00%. That is because the Most Accurate estimate stands at loss of 4 cents while the Zacks Consensus Estimate is pegged at a loss of 5 cents.