Scrap the Playbook — JPMorgan is Our New Defensive Strategy
There is risk in the stock market today where you least expect it.
The stocks that you have historically been told are “safe” have become anything but.
Two separate forces have conspired to make one of the markets most defensive stock sectors risky.
This is a sector where you absolutely should NOT be putting new money.
Today, I want to explain these two specific forces that have conspired to make this happen, and provide you with a safer income-producing investment fit for your portfolio.
Let’s get to work.
Utilities — Still Boring, But the Valuations Are Now Dangerously Risky
Owning shares of utility companies is meant to add stability to your portfolio.
These stocks are considered to be defensive with businesses that are non-cyclical in nature.
When the economy crumbles, these boring (but steady-eddy) businesses don’t.
I do not disagree with that logic. Utilities continue to be predictable, recession-resistant businesses.
The problem for investors today is that while these businesses are still stable, the valuations in the sector have become unattractively expensive. AKA there is a lot of downside from current utility valuations.
The sector currently trades at 19.2 times trailing earnings. That is a very rich valuation for a group of reliable but slow growth companies.
A valuation of almost 20 times earnings implies that a company should be posting consistent double-digit earnings growth year after year. But utilities grow at half that rate.
This is also a valuation that is 30% higher than where the sector has traded over the past twenty years.
Your takeaway from this is that from these valuations offer very little upside but plenty of downside.
The Causes — Index Funds and Low Interest Rates
There are two forces at work that have driven utility valuations to where they are today.
Force #1 is the byproduct of years of “easy money” policies by central banks.
As I’m sure you have noticed in this world of rock bottom interest rates, it has become very hard to find a decent income stream.
As a result, investors desperate for yield have been attracted to the steady dividends that are offered by utility companies.
As investor cash has poured into the sector, it has driven valuations up and dividend yields down.
Force #2 is the massive increase in money being managed by passive index funds and ETFs (as opposed to actively managed funds).
Unlike an active fund which has a human manager picking stocks, a passive fund buys stocks with no thought given to valuation or business performance.
While an active manager might have no interest in a utility trading at a lofty valuation of 20 times earnings, a passively managed fund doesn’t care.
As long as money is flowing into the passive fund, the fund continues to buy, buy, and buy some more regardless of valuation.
Currently, a whopping 9.8% of the utility sector is owned by passive investment funds. There is only one other sector in the entire market that has had its valuation impacted as much by this mindless investment style.1
Today’s Best Income-Generating Alternative
The utility sector is too expensive today for new money. But that doesn’t change our need to find investments that generate income.
A much better alternative today is a world-class company that is hiding in plain sight.
JPMorgan Chase & Co. (JPM) is the second most profitable company in the world, trailing only Apple Inc. (AAPL).
Meanwhile, its fortress-like balance sheet and valuation of just under 12 times earnings provides the defensive valuation that the utility sector currently lacks.
Also, this behemoth bank just got approval to pay a dividend of $0.90 per quarter, which equates to a 3.2% dividend at the current share price.
This is the kind of income we are looking for!
The best part is that JPMorgan’s dividend payout ratio is just 30%, so there is plenty of room to increase that dividend as we move forward.
Again, this is something that you won’t get from today’s utility sector.
And it’s why even though the investment playbook usually points to the utility sector for these types of investments, I’m recommending today that you draw up a new play with JPMorgan.
Here’s to looking through the windshield,
Financial Analyst, The Daily Edge