Despite a strong rally this year recently, the Utilities sector holds a dual appeal, offering both AI and defensive exposure to investors “at undemanding valuations,” Goldman Sachs (NYSE:GS) strategists said in a Wednesday note.
The sector has outperformed recently, with a 16% return over the past three months, ranking in the 98th percentile since 2002. According to Goldman, this surge has been chiefly driven by valuation expansion rather than near-term earnings improvements.
In the note, the Wall Street firm highlighted that Utilities are trading at a 6% price-to-earnings (P/E) premium to the equal-weight S&P 500, which is in line with historical averages. However, adjusting for long-term growth, driven partly by AI-related power demand, the sector's PEG ratio ranks in just the 24th percentile historically.
"Our equity analysts remain above consensus on 2026 EPS, implying room for additional positive revisions," Goldman analysts wrote.
AI represents a key factor in the long-term growth prospects for Utilities, Goldman notes, with the sector expected to benefit from increased power demand related to data centers and AI applications.
The firm forecasts a 2.4% annual growth in US power demand from 2022 to 2030, compared to 0% over the last decade, fueled by a mix of “AI demand, ex-AI demand, and a deceleration in the pace of energy efficiency gains,” strategists said.
In turn, this expansion is poised to lead to higher capital expenditures among Utilities companies, which, given many are regulated entities, is necessary to capture incremental earnings.
Utilities also provide defensive exposure to investors, which is particularly attractive in the current economic climate, with equities pricing roughly 3.5% real GDP growth.
“This is broadly consistent with the current economic environment, as GS Economics’ 2Q GDP growth is tracking at 3.2% and the Atlanta Fed GDPNow estimate is tracking at 3.5%,” Goldman strategists said.
“However, our economists expect real US GDP growth will gradually slow to roughly 2% over the next few quarters. This environment, or a less-benign negative growth shock, would support owning defensive industries such as Utilities in the portfolio,” they added.