NEW YORK (TheStreet) -- The drought in California has made everyone aware of the value of water. The water utility industry, made up of municipally owned and privately owned utilities, have the responsibility of supplying water to households and businesses.

The utility industry is facing serious challenges, however, such as water scarcity, increasing cost of supplying safe and reliable water, financing and building advanced metering infrastructure. Just as important is the challenge of educating the public that it will have to pay more for water.

So what are the best water utilities companies investors should be buying? Here are the top three, according to TheStreet Ratings, TheStreet's proprietary ratings tool.

TheStreet Ratings projects a stock's total return potential over a 12-month period including both price appreciation and dividends. Based on 32 major data points, TheStreet Ratings uses a quantitative approach to rating over 4,300 stocks to predict return potential for the next year. The model is both objective, using elements such as volatility of past operating revenues, financial strength, and company cash flows, and subjective, including expected equities market returns, future interest rates, implied industry outlook and forecasted company earnings.

Buying an S&P 500 stock that TheStreet Ratings rated a buy yielded a 16.56% return in 2014 beating the S&P 500 Total Return Index by 304 basis points. Buying a Russell 2000 stock that TheStreet Ratings rated a buy yielded a 9.5% return in 2014, beating the Russell 2000 index, including dividends reinvested, by 460 basis points last year.

Check out which water utilities companies made the list. And when you're done, be sure to read about which biotech companies to buy now. Year-to-date returns are based on May 29, 2015, closing prices. The highest-rated stock appears last.

Image placeholder title

MSEX

data by

YCharts

3. Middlesex Water Company

(MSEX) - Get Report


Rating: A

Market Cap: $352.4 million

Year-to-date return: -5.3%

Middlesex Water Company, through its subsidiaries, provides regulated and unregulated water, and wastewater utility services. The company operates in two segments, Regulated and Non-Regulated.

"We rate MIDDLESEX WATER CO (MSEX) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its increase in stock price during the past year, growth in earnings per share, increase in net income, revenue growth and good cash flow from operations. We feel its strengths outweigh the fact that the company shows low profit margins."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The stock has risen over the past year as investors have generally rewarded the company for its earnings growth and other positive factors like the ones we have cited in this report. Looking ahead, unless broad bear market conditions prevail, we still see more upside potential for this stock, despite the fact that it has already risen over the past year.
  • MIDDLESEX WATER CO has improved earnings per share by 10.0% in the most recent quarter compared to the same quarter a year ago. The company has demonstrated a pattern of positive earnings per share growth over the past two years. We feel that this trend should continue. During the past fiscal year, MIDDLESEX WATER CO increased its bottom line by earning $1.14 versus $1.03 in the prior year. This year, the market expects an improvement in earnings ($1.20 versus $1.14).
  • The net income growth from the same quarter one year ago has greatly exceeded that of the S&P 500, but is less than that of the Water Utilities industry average. The net income increased by 14.7% when compared to the same quarter one year prior, going from $3.17 million to $3.64 million.
  • Despite its growing revenue, the company underperformed as compared with the industry average of 6.8%. Since the same quarter one year prior, revenues slightly increased by 5.9%. This growth in revenue appears to have trickled down to the company's bottom line, improving the earnings per share.
  • Net operating cash flow has increased to $11.43 million or 36.71% when compared to the same quarter last year. In addition, MIDDLESEX WATER CO has also vastly surpassed the industry average cash flow growth rate of -18.30%.
Image placeholder title

AWR

data by

YCharts

2. American States Water Company

(AWR) - Get Report


Rating: A

Market Cap: $1.5 billion

Year-to-date return: 2%

American States Water Company, together with its subsidiaries, provides water and electric services to residential, industrial, and other customers in the United States. It operates through three segments: Water, Electric, and Contracted Services.

"We rate AMERICAN STATES WATER CO (AWR) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its largely solid financial position with reasonable debt levels by most measures, expanding profit margins, notable return on equity, solid stock price performance and growth in earnings per share. We feel its strengths outweigh the fact that the company shows weak operating cash flow."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The debt-to-equity ratio is somewhat low, currently at 0.66, and is less than that of the industry average, implying that there has been a relatively successful effort in the management of debt levels. Along with the favorable debt-to-equity ratio, the company maintains an adequate quick ratio of 1.39, which illustrates the ability to avoid short-term cash problems.
  • The gross profit margin for AMERICAN STATES WATER CO is rather high; currently it is at 54.46%. It has increased from the same quarter the previous year. Regardless of the strong results of the gross profit margin, the net profit margin of 12.03% trails the industry average.
  • The return on equity has improved slightly when compared to the same quarter one year prior. This can be construed as a modest strength in the organization. Compared to other companies in the Water Utilities industry and the overall market on the basis of return on equity, AMERICAN STATES WATER CO has outperformed in comparison with the industry average, but has underperformed when compared to that of the S&P 500.
  • Investors have apparently begun to recognize positive factors similar to those we have mentioned in this report, including earnings growth. This has helped drive up the company's shares by a sharp 37.60% over the past year, a rise that has exceeded that of the S&P 500 Index. Looking ahead, the stock's sharp rise over the last year has already helped drive it to a level which is relatively expensive compared to the rest of its industry. We feel, however, that other strengths this company displays justify these higher price levels.
  • AMERICAN STATES WATER CO has improved earnings per share by 14.3% in the most recent quarter compared to the same quarter a year ago. This company has reported somewhat volatile earnings recently. But, we feel it is poised for EPS growth in the coming year. During the past fiscal year, AMERICAN STATES WATER CO reported lower earnings of $1.56 versus $1.60 in the prior year. This year, the market expects an improvement in earnings ($1.64 versus $1.56).
Image placeholder title

AWK

data by

YCharts

1. American Water Works Company, Inc.

(AWK) - Get Report


Rating: A

Market Cap: $9.5 billion

Year-to-date return: -0.8%

American Water Works Company, Inc., through its subsidiaries, provides water and wastewater services in the United States and Canada. The company operates through two segments, Regulated Businesses and Market-Based Operations.

"We rate AMERICAN WATER WORKS CO INC (AWK) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its growth in earnings per share, increase in net income, revenue growth, expanding profit margins and solid stock price performance. We feel its strengths outweigh the fact that the company has had generally high debt management risk by most measures that we evaluated."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • AMERICAN WATER WORKS CO INC has improved earnings per share by 12.8% in the most recent quarter compared to the same quarter a year ago. The company has demonstrated a pattern of positive earnings per share growth over the past two years. We feel that this trend should continue. During the past fiscal year, AMERICAN WATER WORKS CO INC increased its bottom line by earning $2.39 versus $2.07 in the prior year. This year, the market expects an improvement in earnings ($2.61 versus $2.39).
  • The net income growth from the same quarter one year ago has greatly exceeded that of the S&P 500, but is less than that of the Water Utilities industry average. The net income increased by 17.5% when compared to the same quarter one year prior, going from $68.12 million to $80.04 million.
  • Despite its growing revenue, the company underperformed as compared with the industry average of 6.8%. Since the same quarter one year prior, revenues slightly increased by 2.8%. This growth in revenue appears to have trickled down to the company's bottom line, improving the earnings per share.
  • 44.65% is the gross profit margin for AMERICAN WATER WORKS CO INC which we consider to be strong. It has increased from the same quarter the previous year. Regardless of the strong results of the gross profit margin, the net profit margin of 11.46% trails the industry average.
  • The stock has risen over the past year as investors have generally rewarded the company for its earnings growth and other positive factors like the ones we have cited in this report. Looking ahead, the stock's rise over the last year has already helped drive it to a level which is relatively expensive compared to the rest of its industry. We feel, however, that the other strengths this company displays justify these higher price levels.

Must Read: 

3 Building Products Companies to Buy Now as Construction Booms