While the S&P 500 Utilities index has been one of the weakest in the S&P 500 index in 2015, in the third quarter it was a bright spot. As global economic concerns increased, we think investors found the domestic focused, stable dividend, and earnings provided by the sector appealing. While the Federal Reserve’s possible increase in the Fed funds rate could have an adverse effect, the 10-year Treasury yield has fallen back to approximately 2.0%. The average dividend for the S&P 500 utilities sector constituent was 3.9%.
The utilities index was down 8.6% year to date through September, worse than the 6.7% for the S&P 500 index. However, in the third quarter, the sector’s 4.4% increase was a stark contrast to the 6.9% decline for the broader market.
From a profit perspective, according to Capital IQ consensus estimates, the utilities sector is expected to post earnings growth of 0.9% for the third quarter of 2015 and 1.7% for all of 2015, both ahead of the S&P 500 index that is weighed down by energy and more multinational sectors such as consumer staples. The utilities sector is projected to increase EPS/earnings 7.0% in 2016, below the 10% for the S&P 500.
The utilities sector is known for maintaining relatively high payout ratios compared with the broader market. Since earnings growth may be constrained compared with sectors that introduce new products, such as health care or information technology, utilities tend to offer investors a higher dividend due to their relatively steady cash flows, and as an incentive to buy utilities shares.
According to S&P Capital IQ Equity Analyst Christopher Muir, payout ratios for the utilities sector have been higher than the S&P 1500. The five-year average payout ratio of 69.0% for the sector is more than double that of the S&P 1500.
Utilities Select Sector SPDR (XLU) is the largest ETF offering exposure to the sector. It tracks the S&P 500 sector constituents and has 60% of assets in top-10 holdings; EXC is one of these holdings. The ETF has a 0.15% expense ratio and trades with a $0.01 bid/ask spread.
Vanguard Utilities (VPU) is another sector alternative, though it has more exposure to small and mid-cap companies. The median market cap for VPU of $23 billion was below XLU's $27 billion. The Vanguard ETF is more diversified with top-10 holdings only 49% of assets.