Avoiding The Next PG&E

California utility PG&E alerts its customers about the latest power cuts (image via PG&E's Twitter account)

A Warning Flag For PCG Last Winter

It may seem hard to believe now, but shares of California utility PG&E (PCG) doubled in price last January after the company announced its intention to declare bankruptcy. 

Price performance of PCG from January 15, 2019 to January 29, 2019. 

At the time, I warned investors to avoid PG&E despite its recent doubling. 

Since then, the stock has dropped 

What was the red flag that caused me to warn investors away from PG&E at the end of January? I realize some wags may suggest the bankruptcy filing was the warning flag, but recall that that wasn't enough to keep investors from bidding up the stock afterwards - enough investors clearly thought the equity would have significant residual value. The red flag I looked at was optimal hedging cost. 

On January 28th,  the smallest decline you could hedge against was 30%, and the cost of that protection was a whopping 29.14% of position value. 

Optimal hedge on PCG from January 28th

Optimal Put Hedge on PCG on January 28, 2019.

By way of comparison, the cost of hedging my local utility, Public Service Enterprise Group (PEG) in the same manner was 0.86% of position value. 

Optimal hedge on PEG as of January 29, 2019

Optimal hedge on PEG on January 28, 2019

A Useful Metric For Non-Bankrupt Names Too

That was a pretty extreme difference in hedging cost, with PCG being more than 30 times as expensive to as PEG, but this can be a useful metric for non-bankrupt names as well. Another comparison of stocks is apposite here: General Electric (GE) versus its fellow industrial conglomerate United Technologies (UTX). Out of curiosity, I compared the hedging costs of GE and UTX on January 28th as well, since there were concerns about GE's balance sheet at the time. GE was 4 times as expensive to hedge as UTX. Here's a chart of how all four stocks - PCG, PEG, GE, and UTX have done since:

Performance of PEG, PCG, GE, and UTX since January 29, 2019

Performance of PEG, PCG, GE, and UTX since January 29, 2019.

As you can see, the two names with the lowest optimal put hedging cost, PEG and UTX, outperformed. Granted, that won't happen in all cases, but it's a useful tool for your investing toolbox when your trying to decide between two stocks in the same industry. 

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David Pinsen 5 years ago Contributor's comment

PEG workers are on their way to help out PCG:

twitter.com/.../1188907116196696065?s=20