Water utilities provide something we can't live without. That reality provides a stable and reliable customer base for water stocks such as American Water Works (NYSE:AWK) and Aqua America (NYSE:WTR), which in turn allows for growing dividend payments and operating cash flows.

The admirable characteristics of the industry's business models and opportunities for growth haven't been lost on investors. Both stocks have posted year-to-date gains of 13.5%, whereas the S&P 500 has returned only 10% thus far in 2017. But if you could choose only one, which would be the better buy: American Water Works or Aqua America?

Water dripping from a tap.

Image source: Getty Images.

Head-to-head

One thing for investors to consider in this head-to-head match-up: Does size matter in the water utility space, and if so, how much? American Water Works weighs in at a hefty $14.5 billion, while Aqua America is a still respectable $6 billion. Is the former better able to meet infrastructure investment requirements in the coming years, or will its expansive holdings slow the company down?

Similarly, the fragmented nature of the water and wastewater industries provides an opportunity for growth for well-positioned companies. Will the smaller Aqua America be more nimble and better able to capitalize, or will the broader financial reach of a larger peer have the upper hand?

With that in mind, let's consider normalized metrics for current valuation and future growth expectations.  

Metric

American Water Works

Aqua America

Price/sales

4.38

7.35

Price/book

2.74

3.21

Forward P/E

24.8

23.4

PEG ratio

3.5

4.7

Data Sources: Yahoo! Finance, Google Finance, investor presentations.

Despite the conventional wisdom that smaller companies grow faster, the larger American Water Works owns an advantage in all current valuation and future growth metrics except for its forward P/E ratio, in which it barely lags behind its challenger. It trades at a lower price-to-sales and price-to-book ratio than Aqua America, and a lower PEG ratio shows that analysts are expecting it to achieve higher growth rates in the next five years.

These advantages have certainly been on display in the head-to-head total returns of each stock in the previous five years. In fact, Aqua America trails the returns of the S&P 500 when dividends are included in this period.

WTR Total Return Price Chart

WTR Total Return Price data by YCharts

To be fair, American Water Works has earned its outperformance of both the S&P 500 and its smaller peer. The water utility has grown operating cash flow and dividends paid 42% and 75%, respectively, since the end of 2013. That's far ahead of the gains Aqua America achieved in the same period.  

Metric

American Water Works

Aqua America

Operating cash flow growth (3-year)

42%

8%

Dividends paid growth (3-year)

75%

28%

Operating cash flow per share in 2016

$7.16

$2.23

Source: Google Finance, Investor presentations.

OK, but how do the two compare in future growth potential beyond the two metrics in the first table?

Aqua America plans to spend $1.2 billion in capital expenditures to modernize its asset base between this year and the end of 2019. American Water Works will spend that much on regulated infrastructure upgrades in 2017 alone, and up to $5.9 billion on infrastructure between this year and 2021. In fact, management expects to spend up to $15 billion on infrastructure in the next 10 years, and up to $40 billion in the next quarter-century.  

That level of investment is made possible by an industry-leading operating cash flow. As upgrades are made, less money needs to be spent on maintenance and repairs, which allows existing assets to generate higher returns over time, thus leading to even higher operating cash flow. In other words, the gap between American Water Works and its peers may continue growing for the foreseeable future, rather than shrink because of any disadvantage investors may think is derived from its larger size.

The better buy is...

American Water Works is the better buy in this matchup based on analyst projections, historical performance, and growth plans. The company's size gives it an advantage over smaller peers such as Aqua America for pouring much-needed investment into water and wastewater infrastructure and also for pouncing on opportunities within the fragmented industry. That could have a positive feedback effect, which would further increase the gap between the two companies over time. Investors interested in water stocks should give this one a closer look.

Maxx Chatsko has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.