"The valuation differential between the most expensive and cheapest utilities stocks stood near an extreme at the end of March, which I think makes particular value names attractive for the longer term," says Douglas Simmons, portfolio manager of Fidelity® Select Utilities Portfolio (FSUTX).
Following are 5 considerations Simmons thinks utilities investors should keep in mind:
- Utilities stocks have rarely performed in line with the S&P 500® index, according to Simmons, who says the sector's return has varied from the broad market by more than 5 percentage points for roughly 80% of historical periods.
- Both in 2019 and early 2020, the top individual stocks within the sector were high-quality defensive names that saw expansion in their stock multiples.
- Valuation spreads widened "tremendously" throughout this period, Simmons says.
- Non-fundamental factors largely drove the performance gap, he adds. "Stocks perceived as relatively safe tended to perform well, as did investments that scored well on environmental, social, and governance metrics," Simmons explains.
- Looking ahead, assuming interest rates remain fairly steady, he believes earnings multiples for the most expensive utilities stocks are unlikely to expand much further.
Based on these 5 considerations, Simmons is focused on owning stocks in the sector with lower price-earnings (P/E) multiples.
As of March 31, the fund's largest investment was in Dominion Energy (D), which Simmons considered one of best-run electric utilities. He says Dominion has been investing heavily in offshore wind turbines and could benefit from federal incentives for utilities that move away from fossil fuels. He also held a substantial stake in Exelon (EXC), which he considered a "deep value play."
Fidelity® Select Utilities Portfolio held securities mentioned in this article on March 31, 2020. As of this date, Dominion Energy composed 12.71% of fund assets and Exelon composed 10.20% of fund assets.
Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.
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