Dear fellow investors,
A mania associated with electric production companies providing electricity to technology enterprises pursuing Artificial Intelligence (AI) agendas looks familiar. An announcement this week by Meta that they signed a deal with Constellation Energy (CEG) and the corresponding surge in the share price of CEG rang a big bell in our minds. Our regular readers will be reminded that a few weeks after the 2024 US presidential election, we made the case that we were in the stock market at the polar opposite of the late-1980 euphoria over President Ronald Reagan’s victory. Stocks were massively under-owned in 1980, interest rates were sky high, and inflation had run rampant.
We will continue this line of logic by comparing where we were in electric production investing in 1981 as compared to today. Someone once said, “Those who don’t know history are doomed to repeat it!” Here are the vital stats on CEG:
Source: Bloomberg.
In 1981, the regulated electric utility companies were forced to pay very high interest rates to borrow money. Investors were scared to death to buy them because their dividends had been eaten up by the inflation of the 1970s and early 1980s. The circumstances got so bad that Congress passed a bill signed by President Reagan, which allowed investors to reinvest their dividends back into the utility company tax-free. As I remember, we bought a slug of Philadelphia Electric shares at 10 times earnings, providing a 12% dividend. You could get up to $2,400 of reinvested dividends tax-free each year. At that time, the 12% untaxed dividend was very competitive with money market interest rates (around 14%), and marginal tax rates were much higher.
Think of the contrast. Constellation Energy was spun out of two major electric utilities, Commonwealth Edison and PECO. PECO is short for Philadelphia Electric Company—yes, the same Philadelphia Electric we were buying in 1981. Is this power generation entity really worth 33.42 times earnings, and is it a good investment to accept 0.49% in dividends from them?
This leads us to the food chain that connects to the AI mania. Microsoft, Meta, Alphabet and Amazon are racing to set up data centers to enhance their cloud computing businesses and to increase their capacity to leverage AI. These data centers and this competitive race fly straight into the face of what made these businesses magnificent: they were asset-light monopolies. In the past, these companies have, for the most part, avoided food fights with each other and have given comfort to buy-and-hold investors.
When the current mania breaks and reality returns to the stock market, what will the market pay for an electricity generation company? Or better yet, what will they pay for clean-burning electricity made out of natural gas?
Play The Long Game,
William Smead
The information contained in this missive represents Smead Capital Management’s opinions, and should not be construed as personalized or individualized investment advice and are subject to change. Past performance is no guarantee of future results. Bill Smead, CIO, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. Portfolio composition is subject to change at any time and references to specific securities, industries and sectors in this letter are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk. In preparing this document, SCM has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. A list of all recommendations made by Smead Capital Management within the past twelve-month period is available upon request.
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