What are we looking for?
Potentially undervalued utility companies.
The screen
Natural-resource company equities have flourished in the first half of the year as the short-term recovery of many commodity prices has reignited investor interest. The S&P 500 energy and materials sectors posted a first-half total return of 16.1 per cent and 7.5 per cent.
Despite increased interest in many riskier assets, defensive sectors have greatly benefited from a flight to safety during periods of heightened volatility and uncertainty. The S&P 500 telecom, utilities and consumer staples sectors generated impressive first-half total returns of 24.8 per cent, 23.4 per cent and 10.5 per cent, respectively.
Many investors have expressed concern over lofty defensive-sector valuations, but there may still be opportunities available. Focusing on the utilities sector for sustainable dividend payouts and stable earnings, my colleague Lawrence Ullman and I used Bloomberg to find the top 10 utility companies from the S&P/TSX composite and S&P 500 with the best mix of:
- Market capitalization (for this screen, we favour lower market cap in the search for value);
- Forward price-to-earnings ratio (lower is better);
- EV/EBITDA ratio (enterprise value to earnings before interest, taxes, depreciation and amortization – lower is better);
- Five-year variability of earnings (standard deviation of trailing 12-month earnings per share over the past 20 quarters divided by the median trailing 12-month EPS – lower is better, values must be less than 1.0);
- Return on equity (higher is better);
- Six-month price change (higher is better).
More about the Ullman Group
The Ullman Group is an independent provider of strategic private capital management services to high-net-worth individuals, corporations, endowments, charities and foundations.
What we found
Using Bloomberg, we performed a back-test starting June 30, 2006, reselecting an equally weighted portfolio of the top 10 qualifying stocks every three months.
Over the entire period, this strategy would have generated an annualized total return of 10.9 per cent (in U.S. dollars) compared with 9.2 per cent for the S&P 500 utilities total return index and 7.4 per cent for the S&P 500 total return index. Over the past year, this strategy would have posted a return of 36.9 per cent compared with 31.5 per cent for the S&P 500 utilities total return index and 4 per cent for the S&P 500 total return index.
The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Ltd. or its affiliates. Investors should contact a professional or do their own research before investing in any of the stocks shown here.
Craig McGee, CFA, is a portfolio manager and Lawrence Ullman, MBA, is a director, wealth management and portfolio manager with the Ullman Group at Richardson GMP in Toronto.
Richardson GMP Ltd. is a member of Canadian Investor Protection Fund. Richardson is a trademark of James Richardson & Sons Ltd. GMP is a registered trademark of GMP Securities LP. Both used under licence by Richardson GMP Ltd.