Centrica and the fear of selling

One of the first companies I bought shares in bought was Centrica. If you’ve ever paid for gas in your home then you’ve probably heard of them. A huge, FTSE250 company with decades of trading history and operating in what is usually considered the ‘defensive’ market of utilities.

When I bought the shares, I loved them. The price was nowhere near it’s all time high, had a generous yield of about 5.5%, and although things had been on a slippery slope for the company for a few years I was emboldened by a friend telling me “if you hold it long enough the dividends will cover any capital loss and the prices usually recover unless the business is in terminal decline. But it’s Centrica right? They’re huge, no need to worry about that”.

I can almost feel the more disciplined readers shaking their heads in despair. This foolish decision to make the initial investment has been followed through to its logical conclusion recently when I took the difficult decision to sell my position and lock in the capital loss. Looking back after all these years I wonder what I was thinking!

So why did I do it?

I believe that this poor investment had two initial causes, following by a lack of discipline on my part which compounded the issue.  You could broadly categorise these as follows;

  1. Paying insufficient attention to price – or too much

Buying the world’s greatest company can still be a colossal mistake at the wrong price. For example, if I buy a company at a P/E ratio of 50, the market is obviously going to react extremely strongly to profit warnings, market shocks and other unexpected news, as investors seem willing to pay a high premium for what they see as ‘guaranteed growth’. Rather than buying into a great story at any price, pay serious attention to the options available – maybe if you wait six months, the price will decline and you can open a position at much more reasonable level.

When I purchased Centrica, the price looked reasonable to me. Nowhere near all-time highs, and I assumed that this gave me a ‘margin of safety’. As I was about to learn, this wasn’t really the case.

  1. Paying insufficient attention to fundamentals

When I originally invested in Centrica, I was just starting on my journey of investment. I was nervous, I was inexperienced and most importantly, I was more willing to listen to the ‘story’ than I should have been. I’d grown up hearing that ‘utilities’ were considered good, defensive companies and I believed that without ever really questioning it. Unfortunately, this led to me buying into a company with slim profit margins, high debt, and a chronic inability to keep hold of customers.

On the other hand I did at least undertake some level of due diligence – I didn’t just flip a coin and decide on Centrica shares. Utilities are traditionally considered ‘defensive’ shares because people can cut back on expensive holidays abroad during a recession but are unlikely to turn off all their heating and cooking gas until they have no other choice. This makes revenues reasonably stable and predictable, even if they fluctuate. That stability is also reflected in the share prices, which are usually pretty steady. The company had grown its revenue and profit for many years and it was an established name in the market.

Unfortunately, the company has and practically always has had, an extremely poor Return on Equity, meaning that it requires significant levels of expenditure to generate a return. High levels of competition have forced prices down and the company is broadly unable to influence global commodity prices, meaning that regardless of its costs going up, it has limited ability to increase prices to cope. It has high levels of debt – including pension debt – which is a big ‘avoid at all costs’ part of my investment strategy for most companies.

  1. An unwillingness to lock in a loss

I never truly believed (and still don’t believe) that Centrica has no future as a business but this gave me perfect cover to hide behind a gradually worsening picture. The longer I held the shares and the further the price fell, the more mentally defensive I came in trying to justify my original purchase.

The problem is that once I’d bought into the position, I’d made the implicit assumption that the price I was paying was ‘fair value’. After all, if I felt it was too expensive, I wouldn’t have invested, right? The further the share fell in value the more I began to defend it.

I found it increasingly hard to make the decision to sell – after all, the price might rebound, right? Better profitability might return. It might have a turnaround in fortune. When the price fell further, I began to wish that I’d sold out earlier – but if I wouldn’t sell at a 20% loss then there didn’t seem to be much sense in selling at a 40% loss.

Of course, this is rather a stupid train of thought. Holding a position in a company is just that – part ownership. Imagine that you owned the company in its entirety. You received all the revenue and paid all the expenses. Everything left was yours after tax. Imagine if you were spending £29bn a year and losing thousands of customers every year. Imagine you lost hundreds of millions of pounds after operating costs. Would you feel like you were doing a very good job? Would you really want to keep pouring money into such a venture for just 6% return?

My answer to those questions would be no. Of course you wouldn’t. But by holding shares in Centrica, that’s exactly what I was participating in – a share of a business that was doing exactly that. By concentrating on the ticker price, I was ignoring the underlying business, which really wasn’t all that healthy.

Conclusion

Holding onto a position because it will hurt to sell it is a little bit like staying in a job you hate because you’re too uncertain to look for another. You’re not in it because you love the work, you can just about tolerate your colleagues, and you don’t really believe you’ll ever get a promotion or a pay rise. The only thing keeping you there is the fear of rejection whilst looking for a new job, the occasional paycheque and a forlorn hope that ‘things will get better’.

Every month you stay in that job your motivation slips. You try a little less hard to progress and gradually lose more respect for the people around you. You become less dynamic, less engaged, less driven to achieve and grow – all the while, watching amazing opportunities pass you by. Your colleagues get promoted, your boss moves on, the company continues to grind you down, and with every month you stay put you waste another month when you could be earning more, learning more, and generally being happier.

My position in Centrica was much the same. The price fell from a peak of about 400p in 2013 around 122p today, the yield has spiked from 4% to over 9%, the company has shed hundreds of thousands of customers and faced collapsed revenues. A few other points to consider in my miscellany of moronic investment criteria;

  1. The company had colossal debts including pension liabilities.
  2. It operated in very expensive and highly competitive markets – badly.
  3. Labour’s ‘Nationalisation agenda’ – oh yes, they’re nowhere near victory, but just the fear of it send the shares tumbling. Still, I continued to hold.

All this, because I was afraid to click the button and admit to myself that I know more now about investing than I did all those years ago. I saw it as admitting defeat and failure but with hindsight, I should have reacted to a steadily declining business and taken action to cut my losses earlier.


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