Usually, defensive stocks act as a hedge and protect principal amid market downturns. What if defensive stocks consistently outperform broader markets over a long period? American Water Works (NYSE:AWK) is one of these stocks.
American Water Works
The stock returned more than 160% in the last five years, including dividends. The return is more than double utilities’ average as well as the S&P 500 (NYSEARCA:SPY). American Water Works stock has been consistently outperforming its peers for the last several years. In the last ten years, the utility returned 480%, including dividends. Meanwhile, the S&P 500 returned approximately 205%.
A defensive and slow-growing water utility consistently beating its peers in the long term by a wide margin is notable. American Water Works could be an attractive pick amid uncertain times, especially during volatile broader markets. Read Time to Go Defensive Due to Rising Geopolitical Risks? to learn more.
The utility operates in around 46 states and serves more than 14 million people in the US. American Water Works provides water and wastewater services to customers. The utility generates a large portion of its revenues from regulated operations, which makes its earnings comparatively stable. Regulated operations usually enable stable and predictable earnings, which eventually facilitates secure dividends.
Fair dividend yield and superior growth
American Water Works’ stable dividends played a big role in driving shareholders’ returns over the long term. Currently, the utility offers a dividend yield of 1.7%, which is approximately in line with the broader markets. However, what makes the utility’s dividend profile striking is its dividend growth. The utility increased its dividends by more than 10% compounded annually in the last five years. In comparison, utility stocks at large exhibited a growth rate of about 4% during the same period. Currently, American States Water Company (NYSE:AWR) yields around 1.5%. The stock has rallied around 34%, while the utility has risen almost 30% in the last 12 months.
American Water Works aims to increase its dividends by 7%–10% per year through 2024, which is in line with its targeted EPS. Utilities generally give away a large part of their earnings in the form of dividends. As a result, they have higher payout ratios. Recently, the utility’s payout ratio was 56% compared to its five-year average payout of 54%. Going forward, the utility expects a payout ratio of around 50%–60%.
Inflated valuation could be concerning
American Water Works stock looks to be trading somewhat weak or flattish from September last year. The stock seems expensive from the valuation standpoint. Currently, American Water Works stock is trading at 31x its estimated 2020 earnings—much higher than its five-year average valuation of around 25x. Such a high valuation multiple for a slow-growing company doesn’t look reasonable.
American States Water Company stock is trading at almost 38x its forward earnings. The stock also appears to be trading at a premium for a slow-growing water utility. Many utility stocks are trading at a premium compared to their historical averages after such an unusual rally last year.
American Water Works forms approximately 2.5% in the Utilities Select Sector SPDR ETF (NYSEARCA:XLU). XLU is the representative of top utility stocks in the country. Notably, XLU has risen 22% in the last 12 months. Read Are Utility Stocks Losing Sheen after a Steep Run in 2019? to learn more.
American Water Works’ target price
According to Wall Street analysts, American Water Works has a mean target price of $126.9 compared to its current market price of $120.5. This implies an estimated upside of more than 5% for the next 12 months.
Among the 13 analysts tracking the utility, six recommend a “hold,” one recommends a “sell,” three recommend a “buy,” and three recommend a “strong buy.”
American States Water stock offers a downside of approximately 10% based on analysts’ mean target price of $75. Currently, the stock is trading at $83.6.
Only three analysts cover American States Water. Two analysts recommend a “sell,” while one analyst recommends a “hold.” None of the analysts recommended a “buy” as of today.
Read Analysts’ Ratings on Top Utility Stocks for 2020 to learn more.