When Your Stocks Don’t Work Out

Real investors make mistakes: What’s important is how you respond.

Welcome to Dividends with Roger Conrad!

On Wednesday, I posted the May issue of my paid service Dividends Premium. The focus is current advice and analysis of Q1 earnings and guidance updates for our 17 top quality, high yielding Income Portfolio companies.

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Hope everyone is having a great weekend. Thanks for reading!—RC

I’ve been in the investment business for 40 years now. And one thing I’ve learned is practically no one in my position ever really owns up to making mistakes.

I suspect that’s for fear of losing customers. That’s understandable. But it’s also a shame.

For one thing, as anyone who’s invested for any length of time knows, losers come with the territory. Investment markets are dynamic. So are individual industries and companies.

Eventually you’re either going to miss something or unforeseen circumstances beyond your control will shake the ground under a company you own. And when either happens, you have a losing stock on your hands.

Pretending not to ever make mistakes is frankly just not credible. But much worse, it makes it practically impossible to learn from the inevitable errors you make.

Those who advise others on investments do need to have a very thick skin. To give you an example, very early in my career I was recommending the utility SCE Corp—now Edison International (NYSE: EIX). Then California announced electricity deregulation, spurring talk about utility bankruptcies from “stranded costs.”

Utility stocks understandably tanked in response, particularly California utilities like SCE. As a result, I got an earful from angry investors in letters and phone calls—I answered them all. And when I addressed the San Francisco MoneyShow in summer 1994, one attendee shouted to the room that I was “dangerous.”

The happy ending to that story is California deregulation proved to be relatively benign for utilities. And despite being at the center of the state’s historic wildfire season this winter, Edison stock has generally been uptrending ever since.

But the experience of that “loser” taught me several investment life lessons that have served me well since.

First, if I was going to stay in the advisory business, I needed to be able to accept criticism and learn from it. And meant having a thick enough skin to admit mistakes.

Second, SCE/Edison proved that just because a stock takes whacking doesn’t mean it won’t recover. I didn’t know when Edison would bounce back. But I did know regulated utilities had an unblemished record of coming back from disaster, including the former Metropolitan Edison—now First Energy (NYSE: FE)—following the Three Mile Island nuclear accident in 1979.

I also found the rationale behind popular forecasts of massive utility stranded cost losses to be on shaky ground. The narrative was that in a competitive market, a new fleet of low cost natural gas power plants would force utilities’ nuclear and coal plants to close.

That held water at what were then sub-$1 per million BTU natural gas prices. But at a higher gas price, you could throw those economics out the window. And in fact, it was the 1990s developers of natural gas power that wound up eventually going bankrupt.

Also, the doomsday scenario didn’t account for the 35 states the just said no to deregulation. And in states like California that did restructure, utilities were able to lobby regulators for pre-recovery of anticipated stranded costs, keeping them whole as they sold power plants to third parties to become the pure grid operators they are now.

So based on that analysis, I stuck with SCE/Edison to very good effect in subsequent years. But I also learned that stocks can fall a lot further and for longer than you might think from looking at their underlying business health.

As I pointed out in last week’s Dividends with Roger Conrad “Who Cares About Company Earnings,” you can often spot trouble at a company by closely monitoring changes in management guidance and keeping tabs on debt—especially changes in debt interest expense.”

But the best way to ensure a losing stock doesn’t blow a big hole in your portfolio is simply to practice diversification and balance. That means watching your weights—never allowing one or two stocks to become such a big piece that a 50 percent decline would blow a big hole in your portfolio.

It also means never, ever doubling down on a falling stock.

I am a big fan of dividend reinvestment plans (DRIPs) and have owned several like Chevron Corp’s (NYSE: CVX) for decades. Every three months (in the case of quarterly dividends), your dividend buys you additional shares, regardless of where the price is. That puts the power of dollar cost averaging to work for you: When the stock is down, you get more shares and therefore more upside in a recovery.

Averaging down in a falling stock does the same thing by cutting your overall cost basis. The problem is it’s all too easily to do this from the standpoint of emotion.

Basically, the more money you throw at a falling stock, I guarantee the harder it will be to bail out, or even to admit what went against you. And if things really get bad, what should be a relatively minor loss to a diversified and balanced portfolio can blow a huge hole in your portfolio very quickly.

In the more than three decades since SCE/Edison, I’ve generally avoided big unrecoverable portfolio blowouts, mostly by following these rules for portfolio balance and diversification.

I certainly had plenty of losers during the great utility stock crash following the 2001 implosion of Enron and Worldcom—some of the toughest months of my career, talk about hate mail! And the same thing happened in the 2007-09 Financial Crisis during which utilities and dividend stocks fared considerably better, and more recently the 2020 pandemic and interest rate spike of 2022-24.

But none of them did the kind of catastrophic damage that portfolios take years to recover from if ever.

My biggest loser of the past couple years far and away has been XPLR Infrastructure (NYSE: XIFR), formerly NextEra Energy Partners. For those unfamiliar, the company is an affiliate of America’s leading electric utility NextEra Energy (NYSE: NEE), which as I’ve pointed out here is also the leading US producer of renewable energy, the operator of the country’s largest natural gas power plant fleet and the world’s seventh largest producer of nuclear power.

XPLR/NEP is essentially a funding vehicle for parent NextEra’s aggressive renewable energy build out. The company follows the once popular master limited partnership model: It issues debt and equity to investors, using the proceeds to buy ownership interests in power plants operated by parent NextEra Energy, which in turn uses that money to invest in other development.

The model of course depends on XPLR/NEP being able to raise capital on economic terms. That’s not always possible. But in the previous decade when XPLR/NEP was shut out of funding, parent NextEra Energy filled the gap. And the result was a massive recovery in shares of what was then NextEra Energy Partners, enabling it to again raise capital and accelerate its pace of acquisitions and dividend growth.

Starting in 2022, the Federal Reserve began raising interest rates to combat what was then nearly double-digit percentage inflation. And XPLR/NEP’s borrowing costs spiked again, just as maturities of CEPFs—convertible equity preferred financing—were approaching.

I made the assumption the parent would again bridge the gap based on three premises. First NextEra Energy is XPLR/NEP’s largest shareholder by far with a vested interest in its recovery. Second, the company also has a strong motive to restore XPLR/NEP’s ability to raise money. And third, the money needed to make the CEPF challenge go away was a literal drop in the bucket for such a large and financially powerful company.

As it turned out, I was dead wrong. Instead, NextEra Energy has basically thrown its affiliate back on its own resources, eliminating XPLR/NEP’s dividend to devote all free cash flow to cutting debt.

The plan looks sound. In fact, XPLR’s Q1 results showed considerable progress, including the pay off of a tranche of CEPFs and strong operating performance for its contracted wind and solar facilities.

But the fact remains that I’m now sitting on a big loss where I once had a gain. And with retrospect, I can see I assumed too much about corporate actions when the market conditions challenging XPLR’s ability to refinance were not improving.

What I did do right is to just keep the bet at the initial position in XPLR/NEP, rather than throw more money at it to average or double down. As a result, it’s just one stock with a big loss in a portfolio that’s otherwise having a pretty good year.

Staying with XPLR/NEP has been a mistake the past two years, no doubt of that. But it didn’t produce a crippling loss. And while I might not keep holding it all the way to recovery, I do have the flexibility to stick around and see if the plan works.