"Investors have given up on the water industry -- the sector has fallen 60% -- but the best firms have hardly missed a beat," says utility sector specialist Roger Conrad.

In Personal Finance, the advisor reviews the outlook for the sector and two of his favorite stocks -- American Water Works (NYSE: AWK) and Aqua America (NYSE: WTR).

"The EPA stimates the US will have to spend $335 billion over the next decade to keep the taps turned on, given aging infrastructure and supply degradation.

"Wealth building is about buying quality on the cheap; and you're not going to find the best water industry stocks at better prices than they sell for now," says utility sector specialist Roger Conrad.

In his The Utility Forecaster, the advisor reviews the three water stocks that earn a place among the core holdings in his growth portfolio: Aqua America (NYSE: WTR), Consolidated Water (NASDAQ: CWCO) and Southwest Water (NASDAQ: SWWC).

"All three of these water stocks posted disappointing first quarter earnings for very different reasons. However, all remain tapped into long-run, wealth-building opportunities.

"Aqua's first quarter results were by no means a disaster. But they lagged both last year's total and Wall Street estimates.

"Management blamed the slowing economy's impact on housing starts in what had been fast-growing systems, rising bad debt, lower commercial sales, delays in fully digesting acquisitions in the South and longer-than-expected timetables needed to win rate increases.

Water utilities are hardly a high-flying investment, but some may be worth a second look. According to EPA estimates, American municipalities will need to spend $500 billion over the next 15 years to upgrade and expand their aging water infrastructure, money most municipalities do not have. Enter privately owned waterworks, including Aqua America (NYSE: WTR) and American Water, currently in the process of being sold by RWE AG in an IPO valued between $4-6 billion. Aqua America currently owns 10,000 miles of pipes in 13 states. The company has a market cap of $3 billion, and recently posted 1Q 2007 earnings of 13 cents per share, just shy of the estimated 14 cents per share. Revenues were up for the quarter 16.5% to $137.3 million. The company also announced a small increase in its quarterly dividend, to 11.5 cents per share.

Aqua America, like its closest competitor American Water, grows primarily through acquisition of smaller water works that can no longer compete on economy of scale. Aqua America has acquired 25 to 30 smaller water companies each year for the past five years. When American Water is finally spun off from its German owner, it will be flush with cash and ready to acquire. The company currently serves 18 million residents in 29 states, and will only get larger. 85% of Americans receive their water via municipal systems, many of which will be prime targets for acquisition.

Investing in waterworks requires an understanding of an unusual business model. Municipalities must agree to sell their waterworks. Scenarios in which municipalities continue to own but contract out waterworks operations are low profit margin deals. Given the impending large bills municipalities will face, they will be more inclined to outright sell to large private waterworks. Once a private waterworks acquires a municipal system, it must spend on upgrades first, then seek to recoup upgrade costs in addition to interest on debt. Much of the debt can be borrowed tax free or tax reduced through municipal borrowing authorities. Typically, a waterworks company spends $3.45 upfront for each $1 in revenue. This is more than twice the cost electrical utilities incur to generate revenue. Private waterworks are also guaranteed a "reasonable" rate of return on equity, generally 10-11%, as part of the acquisition deal.