Year-to-date, the Utilities ETF (NYSEARCA:XLU) has appreciated 21% and the big two telecoms, AT&T Inc. (NYSE:T) and Verizon Communications Inc. (NYSE:VZ), have also appreciated more than 20%. Those are amazing returns especially including the above-average dividend yields utilities and telecoms typically offer.
However, with the bid up prices, it has become riskier to invest new money in utilities and telecoms.
The top five utilities in the XLU are all overvalued, including NextEra Energy Inc (NYSE:NEE), Duke Energy Corp (NYSE:DUK), Southern Co (NYSE:SO), Dominion Resources, Inc. (NYSE:D), and American Electric Power Company Inc (NYSE:AEP).
Reversion to the mean can happen for any of these utilities that are overvalued, and it could mean negative returns in the short term. Read More
No matter investing for growth or income, overpaying for a company will not only reduce your returns but also increase your risk.
For example, during the internet bubble, Cisco Systems, Inc. (NASDAQ:CSCO) reached an all-time-high of $79. The price of buying at extreme overvaluation is an inevitable hard crash. To this day, it hasn’t come near that price.
Cisco was extremely overvalued in the internet bubble.