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For 25 years Investing Daily’s Utility Forecaster has delivered up to 11% annual gains like clockwork from the world’s best high-income plus growth stocks on the planet. At the time this article goes to press, the average gain of Utility Forecaster is 232% on 56 positions currently in its portfolios.

Much of Utility Forecaster‘s success stems from the introduction of two unique systems that add critical levels of protection:

  • Utility Forecaster‘s Safety Rating System
  • Utility Forecaster‘s Early Warning System (also referred to as the DuPont Hybrid Model)

How Do We Perform Our Safety Tests?

Every stock we buy passes through our Utility Forecaster Rating System or “Boot Camp.” Safety Ratings are based on eight financial, operating and regulatory criteria:

  1. Worst estimated annual payout ratio greater than 0% but less than 80%
  2. Increase in dividend over the last 12 months, showing the ability to weather tough times
  3. Less than 10% of earnings from unregulated operations, ensuring consistency of earnings despite economic ups and downs
  4. Bond rating equivalent to BBB- (stable) or higher, from at least one major credit-rating agency, ensuring an investment-grade balance sheet that’s likely to avoid a downgrade
  5. Minimal debt needed to be rolled over through the following year, showing greater ability to withstand the tight credit market
  6. Good regulatory relations, with diversity and/or demonstrated cooperation with officials in key states or federal agencies
  7. Fuel cost exposure neutral or positive (for energy) and free cash flow positive for other groups
  8. Geographic diversification or concentration in recession-resistant regional economy

Criteria vary somewhat from sector to sector to allow for differences in fundamentals. One point is awarded for each criterion met. We determine the rating by adding the number of criteria that is met. For example, a utility meeting five criteria has a “5” rating. “8” is highest (safest), and “0” is lowest (riskiest).

Subscribers may view our “How they Rate” table at www.UtilityForecaster.com/howtheyrate.

Our Early Warning System

The energy utility industry is undergoing a dramatic transformation in this country thanks to a combination of new technology, cheap natural gas, and sweeping environmental regulations. These changes are creating new investment opportunities while also posing threats to some of our existing holdings.

The evolving landscape requires a more proactive approach to monitoring the financial strength and growth prospects of our current recommendations as well as potential additions to Utility Forecaster‘s portfolios.

In response to these developments, we’ve added to our Safety Rating System another layer of protection by incorporating the Early Warning System.

This Early Warning System deconstructs a company’s return on equity (ROE) into its individual components, which allows for greater ease in analyzing what’s actually driving growth. In addition to identifying promising investments, this system alerts us to declining margins, such as those of Exelon and Atlantic Power, and rising leverage at First Energy.

The System’s red and green flash alerts notify our analysts when trends in percentage changes in ROE exceed or fall short of preset criteria. The system then displays customized breakdowns of each company’s fundamentals, offering a snapshot of a firm’s true financial health.

The System, also referred to as the DuPont Hybrid Model, originates from the original DuPont model that was developed in 1919 by a finance executive at EI du Pont de Nemours and Co, and was subsequently employed by numerous other companies to evaluate the critical components that contribute to ROE and hence shareholder value. ROE is still considered a key metric when comparing companies against their peers and is used by many of the world’s top investors, including Warren Buffett.

According to a study conducted by Charles Schwab, ROE also appears closely correlated with the safety and sustainability of a company’s payout. Schwab reviewed the characteristics of dividend payers among the top 3,200 stocks by market capitalization, over the period from 1990 through February 2009, and found that companies with higher ROEs were less likely to have cut their dividend.

The Early Warning System (AKA DuPont Hybrid Model) is the brainchild of Richard Stavros, Utility Forecaster Analyst. In 2005 Mr. Stavros, as Executive Editor of the utility journal Public Utilities Fortnightly, developed with Jean Reaves Rollins, managing partner at The C Three Group, a hybrid version of the DuPont Model to evaluate the financial performance of US utilities.

The three-step DuPont Model shows whether a company is boosting its ROE by improving profitability, using assets more efficiently, or taking on additional leverage. Meanwhile, when using Mr. Stavros’ five-step model to examine two peer companies that have differing ROEs, investors can learn whether the discrepancy exists due to factors such as credit risk and the attendant interest expense, poor deployment of capital, an unwieldy debt burden, or higher operating costs.

Of course, the Early Warning System also has its limitations. While it’s well-suited to evaluating the performance of companies in large established industries such as electric, water and telecommunications utilities, the model is less effective when analyzing firms with highly volatile earnings, such as energy exploration and production companies. The system also shouldn’t be applied to companies that typically distribute all their earnings, such as master limited partnerships (MLPs).

Furthermore, many utilities’ cash flows are cyclical in nature, as they’re highly sensitive to weather-related events. A precipitous, short-term drop in ROE in one quarter may not necessarily indicate that a company’s financials are unraveling. As such, the early-warning system will evaluate trends in ROE across multiple quarters prior to recommending any action with regard to an existing holding or a new opportunity.

We’ve gone back and calculated the stock returns of the top companies on Mr. Stavros’ annual list, year by year. The 10 highest-rated utilities on his first list in 2009 have since returned 43% more than the utility industry as a whole.

His top 10 the following year did 81% better than the industry.

His third annual list fared even better. The 10 most highly-ranked companies according to his model have since risen 60.4%. That’s 151% better than the 24% return posted by the average utility over the same period of time.

A study tracking 3,200 stocks over 20 years found that companies with ROEs in the lowest 20 percent were more than twice as likely to cut their dividends in the following year as those in the top 20 percent. About 14 percent of them made a cut, about one in seven.

Our exclusive Early Warning System is vital, because it means you get an early warning if any of your money is in danger.