Not Just Water Under the Bridge

06/02/2008 12:00 am EST

Focus: STOCKS

Richard Band

Editor, Profitable Investing

Richard Band, editor of Profitable Investing, says water stocks are good long-term holdings in a world short of resources, and he recommends two ways to play it.

Oil prices are front-page news these days—and for good reason.

Happily, there’s little chance we’ll face a worldwide shortage of water any time soon. After all, water covers five-sevenths of the earth’s surface. [But] human beings tend to crowd into relatively small areas (cities), [so] it’s often a major engineering challenge to bring water from its source to where people live.

Water stocks enjoyed a flurry of popularity earlier in the decade, but of late Wall Street seems to have lost interest. For investors with a long-range view, this lull in the action is presenting a wonderful opportunity to build a stake in a “renewable” industry whose profits will most likely never run dry.

The most tempting water play I see right now is American Water Works (NYSE: AWK), the nation’s largest investor-owned water and waste water utility, serving 15.6 million people in 32 states and the Canadian province of Ontario.

American Water continues to be a well-run business, with ample scope to grow organically (more mouths drinking water every year), as well as via acquisition. I’m particularly intrigued with the prospects for industry consolidation, since more than half the 53,000 community water systems in the United States serve a population of 500 or less.

AWK is doling out a quarterly dividend of 20 cents per share, for a current yield of about 3.7%. I look for regular annual increases at a rate that should easily exceed the cost of living.

Any concerns? Like most other water utilities, AWK carries a fair amount of debt. However, the steady Eddie nature of the business dampens this risk. [So,] buy AWK at $22 or less. (It closed at $21.50 Friday—Editor.)

And if you’re reallyexcited about water, you might invest in an exchange traded fund that covers the whole sweep of the industry, PowerShares Water Resources Portfolio (Amex: PHO). In addition to water and waste water utilities, PHO includes pump, valve, tank, meter, and filter manufacturers, as well as companies that build and install irrigation systems.

Both domestic and foreign stocks are represented—an important feature of any well-rounded water portfolio nowadays, since so much of the industry’s growth is taking place overseas in emerging markets. As an index fund, PHO keeps its ongoing costs low (only 67 cents a year per $100 of assets under management).

Performance has been encouraging, too. Last year, when many funds faltered, PHO returned 16.7% at market price. In 2006, the fund racked up an even better 22.2% return. Not bad for an industry based on the commonest raw material in the world. Buy PHO at $22.50 or less. (It closed at $22.70 Friday—Editor.)

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