Assessing the iShares U.S. Utilities ETF (IDU) for a Value Investor's Portfolio

For a value investor, the utilities sector presents a classic case of a durable competitive advantage. These are companies that provide essential public services-electricity, gas, water-whose demand is remarkably insulated from the whims of the broader economy. When the business cycle turns, people still need to heat their homes and power their devices. This fundamental, inelastic demand creates a wide and reliable moat, allowing utilities to generate steady cash flows through economic cycles. The sector's defensive nature was on clear display last quarter, when the S&P Utility Index returned 4.9% while the broader market declined. This resilience is the bedrock of the investment case.

Yet the sector is not immune to market forces, particularly interest rates. Higher rates make bonds more attractive to the conservative investors who often seek utility dividends, and they also increase the borrowing costs for these capital-intensive businesses. The current setup, however, appears favorable. The sector is entering a transformative growth phase, driven by a multi-decade cycle of electrification and the explosive demand from AI data centers. After two decades of flat growth, US electric demand is set for its fastest growth since the 1950s and 70s, with data centers alone projected to nearly triple their share of consumption. This structural shift promises to boost earnings and justify higher valuations for years to come.

For investors seeking exposure, the iShares U.S. Utilities ETF (IDU) offers a convenient vehicle. It tracks the utilities sector with a low cost of ownership, carrying an expense ratio of 0.38%. This is a key factor in long-term compounding. However, the fund's structure introduces a notable concentration risk. Its portfolio is non-diversified, and the top 10 holdings constitute 53.3% of the ETF's assets. This means the fund's performance is heavily tied to a handful of large utility companies, amplifying both potential gains and specific company risks.

The question for a value investor is whether the current price offers a margin of safety. The sector's defensive moat and powerful growth tailwinds provide a strong fundamental floor. The concentrated portfolio, while efficient, demands a higher degree of trust in the underlying holdings. The 0.38% fee is reasonable, but the real cost is the lack of diversification. In a market where utilities are benefiting from a powerful secular trend, the margin of safety may be narrower than in a typical value setup, but the combination of a wide moat and a long growth runway still makes the sector a compelling defensive anchor.

Financial Health and Growth Drivers: Quality of Earnings

The quality of earnings is paramount for a value investor, and the utilities sector's recent performance reveals a powerful, if temporary, earnings acceleration. In the third quarter of 2025, the sector delivered 23.1% year-over-year EPS growth, the third-highest among all S&P 500 sectors. This surge was driven by the explosive demand from AI data centers and a broader electrification trend, providing a clear catalyst for the rally. However, the trajectory is expected to moderate. Consensus estimates point to a slowdown to 9.1% EPS growth for 2026. This deceleration is not a sign of weakness but a natural maturation of the cycle, as the most immediate capital projects begin to contribute to revenue after a typical lag.

The sustainability of this growth is underpinned by a massive, committed capital expenditure program. The sector is funding this expansion with a historic investment wave, planning $208 billion in grid upgrades for 2025 alone and more than $1 trillion through 2029. A critical component is the build-out of power capacity for data centers. The demand is so acute that utilities have already committed to nearly 25-GW of data center power capacity. This is not speculative; it is contracted, shovel-ready investment that will translate into future rate base growth and earnings for years to come. The quality of these earnings is high because they are backed by regulated, long-term contracts for essential infrastructure.

This defensive quality was on full display in the first quarter of 2025, when the sector's resilience was put to the test. While the broader market declined, the S&P Utility Index returned 4.9% compared to a -4.3% decline for the S&P 500. The median return for purely regulated utilities was even stronger at 9.0%. This performance underscores the sector's moat: it is insulated from tariff impacts and benefits from lower interest rates and onshoring trends. The earnings growth is not fleeting; it is being generated by a multi-decade cycle of infrastructure investment that is now in full swing.

For the value investor, the setup is one of high-quality, capital-intensive growth. The earnings acceleration is real and funded by tangible projects, but the path is not linear. The expected moderation in growth rates is a reasonable expectation for a sector that has just completed a period of catch-up. The key is to assess whether the current valuation, which has expanded from a historical discount to trade near a premium, adequately prices in this new, longer runway of investment and earnings. The defensive characteristics demonstrated in volatile periods provide a crucial floor, but the margin of safety now depends more on execution and the pace of demand realization than on simple cyclicality.

Valuation and Interest Rate Risk: The Price of the Moat

The traditional wisdom is that utilities are rate-sensitive, and the logic is sound. These companies carry high debt loads to fund their massive infrastructure, and rising interest rates directly increase their cost of capital. At the same time, higher bond yields make the sector's dividends less attractive to conservative investors seeking yield. This double pressure has long been a source of volatility for utility stocks.

Yet history suggests the stigma is often overstated. The sector's performance is not dictated solely by bond yields but by its regulated, cash-generating model. As one analysis notes, utility stock indexes have kept pace or outperformed broader market indexes year-to-date even in periods of rising rates. This resilience stems from the fundamental mechanism of regulation: authorized returns on equity are designed to track changes in interest rates, providing a built-in buffer. The sector's earnings and stock performance are driven more by rate base expansion and regulatory approvals than by the whims of the bond market. For the value investor, this means the interest rate risk is real but mitigated by a structural floor.

The current price of the iShares U.S. Utilities ETF (IDU) reflects this nuanced reality. The fund trades at a price-to-earnings ratio of 17.54, which is notably above its historical average of 15x. This premium valuation is the market's way of pricing in the powerful growth cycle now underway, driven by data center demand and grid modernization. In other words, investors are paying more today for the expectation of higher future earnings, not for a discount to history. The cost of this optimism is the reduced margin of safety.

Income, while a traditional draw, is not the primary attraction at current levels. IDU offers a dividend yield of 2.23%, which is slightly below the category average of 2.29%. This modest yield underscores that the investment thesis is now growth-oriented, not simply income-focused. The ETF's concentrated portfolio amplifies this dynamic, as its top holdings are the very companies executing the multi-billion dollar capital plans that justify the elevated P/E.

The bottom line is that the price of the moat has risen. The sector's defensive qualities and regulatory advantages provide a durable foundation, but the current valuation leaves little room for error. For a value investor, the key question is whether the growth trajectory can consistently meet the high expectations already baked into the price. The historical ability to navigate rising rates is a positive, but it does not guarantee that the premium multiple will hold if the growth cycle slows or if interest rates spike faster than regulatory mechanisms can adjust. The margin of safety here is narrower, defined more by execution than by cyclicality.

Catalysts, Risks, and What to Watch

The investment thesis for the utilities sector now hinges on a few clear forward-looking scenarios. For a value investor, the primary catalyst is the execution of capital projects. The sector's explosive earnings growth is directly tied to its ability to build the power capacity for data centers and industrial users. The demand is real and contracted, but the earnings visibility depends entirely on the speed and efficiency with which utilities can deploy capital. This is the engine that will justify the current premium valuation.

The main risk, however, is a sustained rise in interest rates. While the sector's regulated model provides a buffer, higher rates increase borrowing costs for these capital-intensive businesses and make their dividends less competitive with bonds. This dual pressure can compress valuations and squeeze margins, testing the resilience that has been demonstrated in past cycles. The risk is not theoretical; it is the fundamental friction that the sector's growth must overcome.

The key watchpoints are the pace of contracted data center power demand and the Federal Reserve's policy trajectory for the next 12 to 24 months. On the demand side, the sector has already committed to nearly 25-GW of data center capacity. The critical metric will be whether this contracted volume translates into timely regulatory approvals and construction starts. On the policy front, the Fed's path will dictate the cost of capital and investor appetite. The sector has shown it can outperform in rising rate environments, but a rapid or sustained hike could disrupt the current favorable setup.

The ultimate test is whether the sector's earnings growth can sustain the current valuation multiple over the long term. The 23.1% EPS growth in Q3 2025 was exceptional, but the consensus for 2026 is a more moderate 9.1%. The market is paying for a growth cycle that is just beginning, not one that has peaked. If execution on capital projects meets or exceeds expectations, and if interest rates stabilize, the premium multiple could be justified. If growth falters or rates spike, the margin of safety will shrink further. For now, the catalyst is clear, the risk is known, and the watchpoints are set.