Among the many features found in each week’s edition of Value Line’s Selection & Opinion service is a list of the seven best and worst performing industries over the past six weeks. These rankings can be found on the inside back cover of Selection & Opinion. The roughly 1,700 stocks in the Value Line universe are currently divided among about 100 industries. Notably, for the purposes of calculating these results, the performance of each stock is equally weighted to the others in its industry (i.e., irrespective of market capitalization). This data also forms the basis for the Relative Strength price charts found on each industry page in The Value Line Investment Survey.
The period under review for this week’s industry rankings (the six weeks ending May 22nd) has been a challenging time for equities. The Value Line Arithmetic Average declined 3.9% over this stretch, and most other market benchmarks, including the Dow Jones Industrial Average and the S&P 500 Index, were also in the red. Against this backdrop, this week’s best performing list contains a rather odd combination of industries, suggesting that investors are struggling to determine the best strategy to navigate the current turmoil.
Two industries separated themselves from the pack: Biotechnology and Homebuilding, which rose 14% and 10%, respectively, in the six-week period. Our electric utility groups, Electric Utility (West), Electric Utility (East), and Electric Utility (Central), held down three of the next four spots, though the gains were considerably more modest, about 3%.
From an investment perspective, utilities typically don’t travel in the same circles as homebuilders and biotechnology companies. Homebuilding stocks, for instance, were at the forefront of the market’s surge early in this year, resulting in several appearances on our best performing list. During this same stretch, one or more of the electric utility industries could frequently be found among the worst performing industries.
Location is one trait that the homebuilders and the utilities that may be contributing to shared popularity of the homebuilders and the utilities at the moment. The companies in both groups generally operate exclusively in the United States. Geographic diversification is usually considered a virtue by most investors. In the current circumstances, though, the market may well view a lack of international exposure as a good thing in that the macroeconomic concerns contributing to the recent weakness in global equity prices seem to be most acute overseas. For starters, concerns about the euro zone’s ability to navigate its various sovereign debt woes have only intensified of late, with the region now seemingly destined for at least a mild recession. There has also been disconcerting data from China indicating that the red-hot growth exhibited by that nation’s economy is cooling off. By comparison, the U.S. economy appears to be holding up reasonably well. GDP growth, though tepid by the standards of most post-recession periods, figures to remain in the 2%-to-3% range in 2012 and 2013. The fitful, post-bubble recovery of the housing market should contribute to these gains. Most notably for the homebuilders, this figures to include strong, double-digit growth in housing starts, albeit off of very depressed levels.
Meanwhile, comparing the basic investment characteristics of the homebuilding and utility stocks provides plenty of indications why these groups usually follow such different paths. Utility stocks, for starters, get high marks for Price Stability (median score: 95 out of 100) and Earnings Predictability (75 out of 100). On these same measures, the homebuilders can be found at the other end of the spectrum, with scores of 20 and 10, respectively. Income is another obvious point of differentiation. The median dividend yield for an electric utility is nearly 4.5%, meaning quarterly cash payouts will usually represent a significant portion of an investor’s total return. By comparison, the typical dividend paying stock in the Value Line universe offers a yield of 2.4%, while the majority of the homebuilders don’t have a recurring cash payout.
Investors who put the most emphasis on stability and predictability may want to take a closer look at SCANA Corp. (SCG) or Southern Company (SO). These two utilities get top scores for both Price Stability and Earnings Predictability. Those willing to accept some incremental volatility in exchange for a higher yield will likely be more interested in Pepco Holdings (POM) and TECO Energy (TE). These equities don’t score quite as well for Price Stability, but both offer yields in excess of 5.5%. By comparison, the yields on SCG and SO are roughly comparable to the industry average.
The trade-off for utility investors is usually long-term appreciation potential. The median price-appreciation potential for the group is just 10%, well below the 80% median for the Value Line universe. As a whole, the homebuilding industry doesn’t stand out either for the long term (median appreciation potential: 45%), but a handful of these stocks will likely appeal to patient, risk-tolerant investors seeking attractive investment gains over the next 3 to 5 years. For these investors, PulteGroup (PHM) stock is probably worth a closer look. For 2012, the company looks set to generate its first full-year profit since the collapse of the housing bubble more than five years ago. Moreover, its current emphasis on improving its operating structure, though likely limiting its progress on new order growth in the near term, should pay off in the long run, positioning investors to realize above-average price appreciation to 2015-2017.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.