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Feature Article

Stay Focused

By Roger S. Conrad on May. 8, 2016

At this juncture, investors should take some profits off the table in stocks that have rallied to unsustainable levels—one reason why the number of Sell-rated names in the Utility Report Card continues to grow.

US water utilities deserve their reputation as safe-haven investments. Not only do these companies operate regulated monopolies, but demand for water and wastewater treatment also remains steady throughout the economic cycle. And water utilities automatically recover their investment in replacing water mains and other infrastructure without filing formal requests for rate increases.

As for growth opportunities, financially stretched municipalities that can’t afford to maintain their aging systems and keep up with growing demand increasingly opt to sell these assets to publicly traded water utilities.

These strengths have convinced risk-averse investors to pay almost any price for exposure to the industry. Check out this graph of California Water Service Group’s (NYSE: CWT) price to earnings ratio over the past two decades.

(Click graph to enlarge.)CWT PE

Despite regulatory delays in implementing California Water Services’ most recent request for a rate hike, the stock has surged to more than 32 times trailing earnings—an unsustainable valuation that historically has marked a top.

In fact, California Water Service’s shares last traded at such a stratospheric multiple in the run-up to the financial crisis and Great Recession. The stock gave up almost 40 percent of its value in that selloff; investors who exited this position when the stock traded at about 30 times earnings fared much better than those who held through the cycle.

Not every water utility rates a Sell in our Utility Report Card. Aqua America (NYSE: WTR), for example, rates a buy on any pullback to less than $30 per share, thanks to its high-quality management team, history of profitable acquisitions and attractive geographic footprint.

Investors should consider taking a partial profit in American Water Works (NYSE: AWK), which trades at 28 times trailing earnings and has transformed from a staple holding for risk-averse investors to a momentum stock.

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