With shares, as with much in life, things tend to run in cycles. A share may at one time may be flavour of the month and considered a very good investment, and another time it couldn’t be more out of fashion.
I see this effect clearly with the utilities. At the turn of the century, the stocks of the moment were tech companies and internet start-ups, which were bid up to crazy levels.
At the time, growth was the key, and mundane, unexciting shares such as the water, electricity and gas companies were unloved and unwanted.
Seeing through the fog of market sentiment
Contrarians and value investors would have seen through the fog of market sentiment and realised that these utility companies were reliable companies which produce steady profits year-in and year-out.
However unfashionable these companies were, they would not suddenly lose their business or their profitability. Canny investors will have seen a once-in-a-cycle buying opportunity.
Anyone who bought Severn Trent (LSE: SVT) shares at the turn of the century would have seen the share price more than triple. And the total return would have been a lot higher, since these companies consistently pay juicy dividends.
Let’s check the fundamentals
So is Severn Trent still a buy? Well, let’s check the fundamentals. The current P/E ratio is 20, which is considerably higher than the FTSE 100 average. The company trades at more than three times book value. Profitability is predicted to be fairly consistent in future years.
However, pressures to reduce water, electricity and gas bills are building. I suspect this will put a lid on future profitability. Plus, crucially, this may turn sentiment negative on the utilities.
But something really stands out: the debt-to-equity ratio. The value of Severn Trent’s debt is far greater than its market capitalisation. You might argue that utilities have a stable revenue stream, and so can live with higher debt levels, but the debt level still seems very high.
This company looks far too expensive
In the round, this means to me that Severn Trent looks expensive. Profitability may be steady, but I can’t see profits increasing substantially in the future. Defensives such as the utilities have been bid up to very high levels.
This is not a share I would consider buying at the moment. In fact, if I were a current shareholder, I would consider taking profits on my holding.
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> Prabhat does not own shares in Severn Trent.