March 4, 2024
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Taking Stock of Your Company Stock: How Much Is Too Much?

As a financial professional I regularly receive many questions from clients and friends about a wide variety of financial issues, mostly regarding the stock market. When I receive a question in shul on Shabbos, I have a standard answer: I do not engage in discussions about personal finance or markets on Shabbos. But during the rest of the week, I entertain any and all questions. I greatly enjoy discussing a wide range of topics including financial markets, investments, economics and wealth management.

Recently I received a question that may apply to others who are employed by publicly traded companies. Many public companies offer a variety of opportunities for employees to invest in their company’s stock. Some of these opportunities include 401(k) plan investments, stock grants and option grants. As an incentive for employees to purchase shares outright, a number of companies offer employees the opportunity to purchase shares of the company stock at a significant discount to the market price.

The individual who approached me is employed by a regional bank in the New York area. After the implosion of Silicon Valley Bank and Signature Bank last month, her company’s stock price plummeted along with the stocks of many other banking and financial companies. Because she has been participating in some of the aforementioned programs, her question was whether it was prudent to sell some of her holdings, even at deflated price levels.

And the Answer Is…

Many times an adviser can answer a question like this with a high degree of conviction. But the answer to this question is fairly nuanced. The first question one should be asking is whether one should be investing in the company’s stock altogether. As the adage goes, “Don’t put all your eggs in one basket.” One’s financial condition should never be subject to the prospects of one company, namely the company that also happens to be one’s employer. If the company’s prospects suddenly turn poor, not only is one’s job potentially on the line, but one’s investment portfolio could be at risk.

The idea of having one’s financial interests aligned with the company’s success may sound like a sensible proposition. If you have “skin in the game,” you are incentivized to work even harder, mutually benefiting both employer and employee. But to what extent should one invest? While some advisers would suggest no more than 10% of one’s net worth, I would suggest looking at the question from two different perspectives.

 

Single Stock Concentration

When portfolio managers build equity investment portfolios, they are likely to have certain strict rules with regard to sector and stock-specific concentration. More specifically, a prudent manager will likely limit exposure to any individual stock. At Caplan Capital, we build diversified equity portfolios by limiting the initial exposure to any one stock to a maximum of 3% of the overall portfolio. When a winning investment appreciates and grows to a higher percentage of the portfolio, we normally reduce the exposure well before that stock approaches 10% of the portfolio. This discipline would suggest that employees should have considerably less exposure to their company’s stock than 10% of their net worth.

Is My Company’s Stock Cheap?

The other major issue is whether the price of your company’s stock represents good value. Employees should consider investing in their company’s stock only if they can definitively determine that the stock price is modest enough by objective criteria and thus warrants an investment. To put a finer point on this argument, I believe one should ask the following questions: If I were not working for my current employer, would I have the same conviction and risk appetite to invest in that company? Or would I rather invest in other stocks that I believe have significantly higher potential for capital appreciation? Am I investing in my company’s stock because I believe it is clearly a good investment or am I doing so just to demonstrate allegiance to my company? Familiarity bias, or the fact that an employee understands the company better than the rest of the investment universe should not be the determining factor. Rather, the relative and absolute value of the company’s stock should inform one’s decision as to whether to invest in the company as well as the size of the investment.

Case Study #1: The Wrong Approach

A number of my friends living in the Highland Park/Edison community were employed by Lucent Technologies in the late 1990s during the dot.com stock bubble. When the bubble began to unravel, some employees continued to invest more money into the company’s stock, thinking that the stock price would inevitably recover. But that never happened. Not only did they lose much of their investment in Lucent, many also ended up losing their jobs. (Lucent was eventually merged with Alcatel in 2006 and then was absorbed by Nokia. But the massive losses were never recovered.)

Case Study #2: The Right Approach

Back in 1999, one of my clients, an executive at Time Warner, had many stock option grants in Time Warner stock that grew to a sizable part of his net worth. When America Online made the offer to acquire Time Warner, he was deeply concerned about the prospects for the combined company. In fact, it turned out to be a disaster for both AOL and Time Warner shareholders.

The client asked me if I could devise a strategy to hedge his exposure to the combined companies’ stock price. I implemented a strategy using listed options that would help offset the potential decline in the stock price. Fast forward about two years and the client was able to salvage nearly the entire value of his company stock options, which became worthless.

Closing Thoughts

Clearly, there are many considerations in determining if and how much employees should invest in their company’s shares. While those who have been employed by a perennially successful company may have enjoyed the benefits of their company’s stock price ascent, there are many other stories of errors and miscalculations made by employees, who later regretted their decision to make a meaningful investment. Should you have any questions about whether and how much you should invest in your company’s stock, please feel free to contact me at [email protected] (but, of course not on Shabbos!).

The views presented are those of the authors and should not be construed as personal investment advice or a solicitation to purchase or sell securities referenced in this market commentary. The authors or clients may own stock or sectors discussed. All economic and performance information is historical and not indicative of future results. Any investment involves risk. You should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice. All information is obtained from sources believed to be reliable. However, we do not guarantee the accuracy, adequacy or completeness of any information and are not responsible for any errors or omissions or from the results obtained from the use of such information.


Jonathan D. Caplan, a former Wall Street executive, is president and founder of wealth management firm Caplan Capital Management, Inc., with offices in Highland Park and Hackensack. He holds a BA from Yeshiva University and an MBA in finance from New York University Stern School of Business. You can find other recent investment articles by Jonathan at www.caplancapital.com/blog.

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