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REITs And Utilities Are Expensive... Here Are Some Of My New Income Holdings

Summary

From a valuation point of view, utilities make no sense.

REITs are even more expensive than utilities.

I like these stocks instead.

I use to like REITs and Utilities for Income, but not anymore.

Most are expensive! I wrote once again last week about the valuation problems that the Utility, REIT, and Blue-chip dividend paying stocks were facing. I gave specific examples of profitable sells that I had made in early July, particularly in the REIT sector.

Amongst the numerous comments that my article received, many challenged me to give some specific examples of the new areas of the market that I was pivoting to in order to find income.

Well, here you go…

First, I want to review the facts that led me to the conclusion that many dividend paying sectors in the market were extremely expensive right now. I wrote about that back on July 5th.

I did not just drop off of the turnip truck as it relates to valuations. This is my third decade as a professional money manager. I spent several years visiting companies around America and writing up research reports on them, valuation is the biggest part of that exercise.

What is the bottom line of a research report? It comes down to the potential earnings of the company going forward, and how much are those earnings worth?

It is obviously not quite as simple as that, but almost. Then, once I would arrive at a potential future valuation of the company, I would compare it with the current price. At any given time, a stock is undervalued, fully valued, or overvalued.

I like to compute 5-year valuations. They fit nicely with the five-year growth rates that are common in the industry. In fact, you can look up my target prices on thousands of stocks each and every day in my Best Stocks Now database.

I do not like to buy stocks unless I can make a reasonable valuation case for them. As valuations get stretched, risk to reward ratios rise. One way you can mitigate risk in a portfolio is by mitigating valuation risk. It is not a good idea to have a portfolio of expensive stocks.

It is hard to make the case for buy and hold to an investor like me that pays attention to valuations. Why would I continue to hold on to a stock that has become stretched way beyond historic norms as it relates to valuation? This makes little sense.

Let's first check in on the current valuations of the utilities. Pick a utility, any utility. How about NextEra Energy (NYSE:NEE)? Why not? It is the biggest holding in the iShares U.S. Utilities ETF (NYSEARCA:IDU) which tracks the U.S. utilities index. The company provides electricity to about 5 million folks in Florida every days.

Over the last ten years, the P/E ratio for NextEra has ranged between a low of 11 and a high of 23. I use Morningstar.com as my source. The ten-year average P/E ratio has been somewhere in the 15X range. The current P/E ratio is 22X. This is obviously a very stretched valuation from a P/E ratio point of view.

Let's next look at the price to sales ratio of NextEra. It has ranged between a low of 1.2 to a high of 3.4 over the last ten years. The average price to sales ratio has been in the 2X area. The current price to sales ratio is 3.4. This too is obviously a very stretched valuation.

How about price to book value? It is yet another flavor of valuation. The range over the last ten years has been between 1.7 and 2.6. The current price to book ratio is 2.6. One would have to see continued multiple expansion way beyond their historic norms to be able to justify today's valuation ratios. That is a bet that I am not willing to take.

The price to cash flow multiple is also stretched to the max. No matter what flavor of value that you like best, they are all currently way too rich.

You could make the argument that NextEra's dividend yield of 2.8% looks pretty attractive in today's low yield...


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