Macro Wrap – How Expensive are Staples and Utilities, $XLP, $XLU?

by Enis May 17, 2013 7:36 am • Commentary

I did a detailed run through of the largest health care names in my macro wrap earlier this week.  My main conclusion was that health care is not overvalued as a sector, but the staid, dividend payers (like MRK, BMY, and LLY) are much less appealing on a growth vs. valuation perspective than the rest of the sector, while UNH and biotech looked attractive.

But consumer staples and utilities are another story.  These are defensive sectors where almost all of the stocks look overvalued, on a relative and historical basis.  Here is a very quick run through of current P/E, dividend yield, and projected earnings growth of 10 of the largest names by market cap among these 2 sectors:

  1. PG – 20 P/E, 6% EPS growth, 3% dividend
  2. KO – 21 P/E, 8% EPS growth, 2.6% dividend
  3. PM – 18 P/E, 10% EPS growth, 3.5% dividend
  4. WMT – 15.5 P/E, 8% EPS growth, 2.4% dividend
  5. PEP – 20 P/E, 8% EPS growth, 2.7% dividend
  6. MO – 16 P/E, 8% EPS growth, 4.7% dividend
  7. CL –  23 P/E, 8% EPS growth, 2.2% dividend
  8. DUK – 17 P/E, 3% EPS growth, 4.3% dividend
  9. SO – 17 P/E, 3% EPS growth, 4.4% dividend
  10. D – 20 P/E, 8% EPS growth, 3.7% dividend

So for the most part, this is a 20 P/E environment for these stocks, mostly growing EPS 5-10% per year, paying a dividend of 2.5-5%.

The problem is that at 20 P/E, these stocks are starting to become mostly risk, without much reward.  Multiple appreciation has been a general tailwind for these stocks for the past 2 years, and while psychology might get more excited with them for the simple reason that the prices are rising, the fundamental earnings power has not changed much in that period.

Obviously, I’m painting with a very broad bush.  But on a purely quantitative basis, of the stocks above, WMT and MO are the only 2 that are reasonably priced in my view.  The rest are lackluster investments at best, and significantly overpriced at worst.  The utilities are especially poor long-term propositions, given that they rarely grow EPS 10% in any given year, but can see earnings contract in a bad year.  Their 4% dividend is simply not enough compensation for the risk.

I have not tried to short any stocks in either of these sectors at any point this year, and I won’t attempt a short entry here.  While I’m fundamentally bearish on many of them, price action has not shown enough weakness for me to get involved.  However, if sellers do start to take control in the coming months, my radar is on high alert for short opportunities.  The “safety-buying” is close to over in my view.  Long-term investors are unloading these shares in search of better opportunities elsewhere, while performance chasers are left with the fumes.