Quality’s Still in Style

Takeovers, tax reform and President Trump dominated the financial headlines in 2017—and all signs point to this trend continuing well into the new year.

When it comes to investment returns, however, quality remains the most important theme. And with valuations still near records, the bull market a year older, and volatility picking up in the utility sector, owning best-in-class names will be more critical than ever to delivering differentiated returns in 2018.

This month’s feature article highlights key trends, as well as our picks and pans, for nine categories of essential-service companies. We also revisit our best ideas from the start of 2017; these picks delivered an average total return of 19.6 percent, walloping the 5.8 percent gain posted by our pans.

Utility stocks often underperform in January, as portfolio managers allocate more capital to aggressive names. This year, the Dow Jones Utility Average’s performance has taken a hit from concerns that California utilities could face billions of dollars in liabilities related to the catastrophic wildfires that ravaged the state.

Although weakness in utility stocks has taken some of our Portfolio holdings down a bit, our position in ProShares UltraShort Utilities (NYSE: SDP) has gained about 15 percent since mid-November. Meanwhile, the pullback in utility stocks has brought a few of our Portfolio holdings below our value-based buy targets.

Our commitment to diversification has also paid off, with several of our holdings rallying in the new year despite weakness in utility stocks. Conservative Income Portfolio holding Pembina Pipeline Corp (TSX: PPL, NYSE: PBA), for example, hit a new high last week, benefiting from the rotation into the energy sector. That’s why we stick with stocks that lag in a given year—as long as they’re backed by high-quality businesses.

Readers should check out this month’s update to the Utility Report Card, which features our take on how US tax reform will affect the each of the roughly 200 companies in our coverage universe. We also revisit the factors behind our proprietary Quality Grades.