By Jacob Sonenshine
Utility stocks are down, but they aren't out. In fact, they're now too cheap to ignore.
The State Street Utilities Select Sector SPDR exchange-traded fund is down 7% from the high hit in mid-October, while the S&P 500 is less than 2% below its high and up a touch since mid-October.
The reason utilities have suffered has nothing to do with their fundamentals, which look fine. Rather, market participants have piled into riskier stocks since mid-October. The Federal Reserve has cut interest rates and begun pumping money into the financial system, which are positives for the economy. So investors have bought up shares of more economically sensitive companies that can benefit, such as financials, consumer names, and industrials. They have prioritized their capital for those areas, leaving out utilities, which see consistent demand regardless of economic conditions.
Now, utilities look attractive. The ETF trades at 17.8 times aggregate earnings forecast for the coming 12 months, 19% below the S&P 500's 22 times. That is at the lower end of the range of discounts the sector has traded at in the past five years.
That multiple is also below this year's peak of about 20 times, even though expectations for earnings growth haven't changed for the group. Long-dated bond yields are essentially unchanged since mid-October, so the present value of expected dividends that utilities pay hasn't changed much either.
One promising name is American Electric Power, an electricity provider for Ohio, Virginia, West Virginia, and other Midwest and a few southern states. The stock is down almost 7% from its peak and trades at just over 18 times earnings.
The valuation of $62 billion is probably too small given the company's growth prospects. For the past few years, American has grown its asset base in the mid-single-digit percentages annually, in line with its peers' growth, to a little over $70 billion today by adding new clean energy plants. EPS has grown at a similar rate because utilities are allowed by their states to earn a certain rate of return on the equity of their assets. That means, as their assets grow, their profits grow.
But American Electric can grow even faster than that, and faster than many of its peers. Management said on its late October earnings release that it plans to grow its asset base by about 10% a year to $128 billion by 2030. That is above the high single-digit growth in asset base that analysts expect from the average utility.
Part of American's projected growth is because the company serves states with data-center construction. Technology companies are rapidly increasing the buildouts of data centers to power artificial intelligence capabilities. With more data centers comes more utility projects to power them.
Overall, "given the clean energy transition still in progress, still accelerating AI computing, data center, and industrial load growth, we expect ...a super-cycle of above typical historical growth," writes Siebert Williams Shank analyst Christopher R. Ellinghaus. He initiated coverage of American Electric this week with a Buy rating.
Analysts on average expect almost 9% earnings per share growth annually through 2030 for American, according to FactSet. The reason EPS will likely grow a bit less than the growth of the rate base because the company plans to issue a modest number of shares to raise money to finance the investments.
American Electric's growth prospects are worth more than the stock's current price. Ellinghaus and other analysts note that utilities with earnings and dividend growth at that rate are intrinsically worth more than 20 times earnings, sometimes about 22 times. Combine a higher multiple with higher earnings over time, and this stock should jump.
Another utility stock in the same boat is Dominion Energy, a $52 billion provider for Virginia and the Carolinas. Barron's recommended it in late November. Since then, it has dipped a few dollars, given the broader drop in utilities.
Virginia has more data centers than any other state, and Dominion should grow above the rate of most utilities. That should lift its valuation, which is currently at just under 17 times.
That spells an opportunity to buy this name at a discount, too.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
December 19, 2025 16:00 ET (21:00 GMT)
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