Imagine you're a pilot who is preparing to land an airplane. You've just eased up on the throttle, thereby slowing your airspeed. To compensate, you gently pull back on the yoke to increase the plane's angle of attack. A buzzer suddenly goes off… it's the stall warning. Your approach is too slow! The aircraft is at risk of rapidly losing altitude and the consequences could be dire.
The concept of a stall speed can apply to economics, as well. That is, economic output tends to transition to a slow-growth phase (stall) at the end of an expansion before the economy falls into a recession.
Right now, a buzzer should be sounding at the Federal Reserve because the U.S. economy has officially slowed below stall speed.
Excluding the impact of inventories, real economic growth in the first half of 2015 was just 0.54%. Lackluster wage growth also indicates continued labor market slack. In the second quarter, the employment Cost Index, a broad measure of labor costs, posted the smallest gain since records began in 1982.
Indeed, recent data further support my view that the risk of a meaningful rise in interest rates is low. And because we're in a subdued economic growth and inflation environment, I believe that the utilities – electricity, gas, and water companies – continue to be viable investments.
However, we must be wary of valuations, especially for relatively high-yielding securities. Investors starved for yield have bid up prices across the utility sector, pushing average valuations to historically high levels. We also want to avoid utilities that are excessively levered.
Luckily, we can help alleviate both of these concerns with the trusty enterprise value-to-EBITDA (EV/EBITDA) ratio.
Remember, the EV/EBITDA ratio compares the total stakeholder value net of cash with the total cash flows available to all stakeholders. Firms with high equity valuations and/or high debt levels have higher (less attractive) EV/EBITDA ratios.