ETF Teardown: The Best Utility Stocks

Noted for their simplicity and other advantages over mutual funds, exchange-traded funds have become a popular investing tool.

ETFs hold collections of stocks that share certain elements. If investors want to capitalize on the increasing demand for basic utilities, for example, they can turn to Utilities Select Sector SPDR, which includes Exelon (NYSE: EXC) and Southern Company (NYSE: SO) in its top holdings. But because this ETF invests in a number of companies, its broad diversity also limits your upside.

Fear not, Fool -- in this edition of "ETF Teardown," we'll use some nifty tools to drill into the best investments in the utilities sector. To help, we'll use Motley Fool CAPS, our tool for screening and ranking stocks and stock pickers.

The power of tags
To help investors locate great stocks quickly, CAPS-rated stocks are "tagged" with descriptors that group the company with others in the same category -- "Department Stores," for example, or "Trucking."

Selecting the "Electric Utilities" label in CAPS gives you a list of 60 companies that trade on American exchanges and carry this tag. This particular collection of investments has done well in the past year, returning 7.5% while the S&P 500 has dropped by 4.7%.

To gauge which companies the CAPS community thinks offer good opportunities in the wireless sector today, we'll sort these businesses by their CAPS star rank, from one to the maximum five stars. We'll then examine the individual companies to see who -- from Wall Street to Main Street -- is bullish or bearish on the business, and why.

Down to the nitty-gritty
Here are some electric utilities stocks I've pulled from CAPS today:

Company	CAPS Rank	Market Cap (billions)
Constellation Energy (NYSE: CEG)	*****	$17.4
Sempra Energy (NYSE: SRE)	*****	$15.2
Dominion Resources (NYSE: D)	****	$25.4
DTE Energy (NYSE: DTE)	***	$7.2
Reliant Energy (NYSE: RRI)	**	$7.9

Power that pays you back
One of the top-rated electric utilities on our list, Motley Fool Income Investor recommendation Constellation Energy, counts itself as the largest competitive supplier of electricity to large commercial and industrial customers in the U.S.

The company also provides both electric and gas utilities through its subsidiary, Baltimore Gas and Electric, and has significant initiatives under way in solar and nuclear energy production. The company has performed exceptionally in a tough environment over the last several years, with the stock advancing 243% in the past five years.

But Constellation is now in the crosshairs of the Maryland Public Service Commission, which issued an interim report to the legislature stating, in essence, that the 1999 deregulation of electricity in the state has hurt consumers and unfairly benefited Constellation. Seeing the threat of increased regulation and potential rebates to consumers, Constellation even filed a federal lawsuit against the state to recoup $386 million in credits given to customers recently.

Maryland Governor Martin O'Malley apparently has little sympathy for a company that just reported record earnings 27% higher than last year and that raises rates to customers to combat the rising cost of commodities. With the governor's intent to force prices down for consumers, Fitch has even come out and placed the company's investment-grade debt on negative watch as it sees risks of regulation increasing.

While the dispute with Maryland's regulatory body is at a volatile point right now, issues over the balance of regulation -- or lack thereof -- come up frequently with utilities companies. Some investors fear the regulatory direction of the future may hurt Constellation, but only a minor portion of the company's earnings are affected. The bulk of Constellation's profits come from its merchant energy business.

A strong contingent of CAPS investors has confidence that company management will navigate the rough waters successfully. Indeed, 197 of 204 investors rating the company say Constellation will continue to beat the market in the future.

You can lead a horse to water ...
Plucking individual stocks from any utilities sector is, of course, a high-risk endeavor. Investors should always perform their own due diligence on companies and not take a recommendation. After all, even the best stock pickers can be horribly wrong on a stock.

So, do you agree that electric utilities will shine in the future? Or will rising commodity costs and the threat of regulation put a chill in utility stocks? Give your own opinion in Motley Fool CAPS.