The Public Utility Sector
In addition to investment trusts, intrinsic values are reasonably well defined for regulated public utilities. The general rule currently applied by regulatory authorities is to allow utilities to earn a fair return on an allowed rate base. The fair return is defined to be equal to the utility's weighted average cost of capital. There are several reasons why a public utility can earn more or less than a fair return, but the target set by the regulatory authority is the weighted average cost of capital.
If a public utility has an allowed rate equity base of $X and is allowed to earn a return of r (rX in terms of dollars), after one year the firm's equity will be worth X + rX or (1 + r)X with a present value of X. Remember that r is the return required by the market as well as the allowed return. The present value of the equity is equal to the present equity rate base, and the stock price should be equal to the equity rate base per share. Given the nature of public utility accounting, the book value of a utility's stock is approximately equal to the rate base. Thus the market value of a regulated public utility's stock should normally be reasonably close to the book value per share.
There can be time periods in which the utility can earn more (or less) than the allowed return. The reasons for this include regulatory practices that differ from the above, regulatory lag, changes in effi
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Publication information: Book title: The Causes of the 1929 Stock Market Crash:A Speculative Orgy or a New Era?. Contributors: Harold Bierman Jr. - Author. Publisher: Greenwood Press. Place of publication: Westport, CT. Publication year: 1998. Page number: 85.
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