FUTY: Utilities Dashboard For September

This monthly article series shows a dashboard with aggregate industry metrics in utilities. It is also a top-down analysis of sector ETFs like Utilities Select Sector SPDR Fund ETF (XLU) and Fidelity MSCI Utilities Index ETF (NYSEARCA:FUTY), whose largest holdings are used to calculate these metrics.

Shortcut

The next two paragraphs in italics describe the dashboard methodology. They are necessary for new readers to understand the metrics. If you are used to this series or if you are short of time, you can skip them and go to the charts.

Base Metrics

I calculate the median value of five fundamental ratios for each industry: Earnings Yield ("EY"), Sales Yield ("SY"), Free Cash Flow Yield ("FY"), Return on Equity ("ROE"), Gross Margin ("GM"). The reference universe includes large companies in the U.S. stock market. The five base metrics are calculated on trailing 12 months. For all of them, higher is better. EY, SY, and FY are medians of the inverse of Price/Earnings, Price/Sales, and Price/Free Cash Flow. They are better for statistical studies than price-to-something ratios, which are unusable or non-available when the "something" is close to zero or negative (for example, companies with negative earnings). I also look at two momentum metrics for each group: The median monthly return (RetM) and the median annual return (RetY).

I prefer medians to averages because a median splits a set in a good half and a bad half. A capital-weighted average is skewed by extreme values and the largest companies. My metrics are designed for stock-picking rather than index investing.

Value and Quality Scores

I calculate historical baselines for all metrics. They are noted respectively EYh, SYh, FYh, ROEh, GMh, and they are calculated as the averages on a look-back period of 11 years. For example, the value of EYh for hardware in the table below is the 11-year average of the median Earnings Yield in hardware companies.

The Value Score ("VS") is defined as the average difference in % between two valuation ratios (EY, SY) and their baselines (EYh, SYh). FY is reported for consistency with other sector dashboards, but it is ignored in utilities' score to avoid some inconsistencies. The same way, the Quality Score ("QS") is the average difference between the two quality ratios (ROE, GM) and their baselines (ROEh, GMh).

The scores are in percentage points. VS may be interpreted as the percentage of undervaluation or overvaluation relative to the baseline (positive is good, negative is bad). This interpretation must be taken with caution: The baseline is an arbitrary reference, not a supposed fair value. The formula assumes that the two valuation ratios are of equal importance.

Current Data

The next table shows the metrics and scores as of the last trading day's closing. Columns stand for all the data named and defined above.

Value and Quality Chart

The next chart plots the Value and Quality Scores by industry. Higher is better.

Evolution Since Last Month

The value score has slightly improved in all subsectors.

Momentum

The next chart plots momentum scores based on median returns.

Interpretation

The sector as a whole was very close to 11-year averages in valuation when I published my broad market dashboard for September. Considered separately, gas and electricity/multi-utilities are on their historical baseline in valuation, and close below it in quality. Water utilities are overvalued by 12% and quality is neutral.

Fast Facts on FUTY

Fidelity MSCI Utilities Index ETF started investing operations on 10/21/2013 and tracks the MSCI USA IMI Utilities 25/50 Index. The expense ratio of 0.08% is a bit cheaper than for the sector benchmark ETF XLU (0.10%).

As of writing, the fund has 69 holdings. The next table lists the top 10 names with fundamental ratios and dividend yields. Their aggregate weight is 51.9%.

Ratios: Portfolio123

FUTY has marginally underperformed XLU since 11/1/2013. The difference in annualized return, maximum drawdown, historical volatility, and risk-adjusted performance (Sharpe Ratio) is insignificant.

Valuation ratios also are very close:

In summary, FUTY is a good instrument with cheap fees for investors seeking a capital-weighted exposure in utilities. It has more holdings than XLU (currently 69 vs. 32), but past performance is almost identical. The two funds are equivalents for long-term investors. However, XLU is a better instrument for tactical allocation and trading, thanks to much higher trading volume. Both funds have a high exposure to the top holding NextEra Energy. Investors looking for a more balanced portfolio may prefer Invesco S&P 500 Equal Weight Utilities ETF (RSPU).

Dashboard List

I use the first table to calculate value and quality scores. It may also be used in a stock-picking process to check how companies stand among their peers. For example, the EY column tells us that a gas utilities company with an Earnings Yield above 0.0534 (or price/earnings below 18.73) is in the better half of the industry regarding this metric. A Dashboard List is sent every month to Quantitative Risk & Value subscribers, with the most profitable companies standing in the better half among their peers regarding the three valuation metrics at the same time. The list below was sent to subscribers several weeks ago based on data available at this time.

It is a rotational model with a statistical bias toward excess returns in the long term, not the result of an analysis of each stock.

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