Wednesday, April 11, 2007

Investing in Your Company Stock: Pros and Cons

My wife will be starting a new position next week, and her new company provides their 401k matching funds in the form of company stock. This is an unsavory practice that I hoped had passed from the world after the Enron scandal. Forgetting about that for minute, I thought I would take the opportunity to write about the pros and cons of investing in your own company stock:

Why You Should Invest in Your Company Stock

1. Understanding Your Investment - Warren Buffet is famous for saying that you should only invest in what you know and understand. One would think that the company you know the most about is the one you actually work for. You know if the company is well run, you know if morale is good, you know what the customers think about your company. In short, you have a lot of information which may allow you to make some intelligent investment decisions.

2. It Is a Company You Believe In - Otherwise why would you be working there?

3. It is Easy - sometimes all you have to do to invest in your company stock is to NOT act. Some companies award stock options or restricted stock to their employees. Others offer an employee stock purchase plan. Sometimes, unless you sell the stock you are awarded, you are automatically an investor.

4. Discounted Stock Offerings - many companies have an employee stock purchase plan (ESPP) which allows employees to purchase company stock at a discount, using a set portion of their salary. These purchases are typically done twice a year, and at the time of purchase you are guaranteed a 15% return on your investment, i.e. free money. Not taking advantage of such gifts is stupid. I intend to write a post about ESPP later this week.

5. You Don't Get a Choice - sometimes you are granted options or stock without having the right to sell them. It's a gift horse, no looking in the mouth please.

Why You Shouldn't Invest in Your Company Stock

1. The Double Whammy - if your company goes under, you lose your job AND your company stock is now worth zilch... can you say ENRON?

2. Restricted Trading - SEC regulations restrict company employees and other insiders from trading the stock at certain periods of the quarter. The blackout period lasts until your company releases its quarterly earnings statement each quarter. During this time your investment is completely illiquid by law. If your company will be releasing some bad news, you may be stuck holding a bad investment with no way to get out.

3. Bias - When I work for a company, I tend to think that my company is superior to the competition, whether this is true in reality or not. I have no proof of this, but I suspect that many people share the same positive biases towards the company they work for. A biased investor is a poor investor. If you can't keep a sober market outlook, you should probably not be investing in your company's industry sector at all.

4. Diversification - I recently read a post on My 1st Million at 33 (an excellent PF blog that I strongly recommend) in which Frugal explains that about 20% of his investment portfolio is invested in his company's stock. Frugal's appetite for risk is much higher than mine, and he is a sophisticated investor, but I don't care how much you love a company, or how great you think its prospects are, holding 20% in ANY one stock makes for a very undiversified portfolio. I shared my opinion with Frugal in a comment on his post (Hi, Frugal!)

Bottom line, there are definitely some advantages for investing in your company stock, and under some conditions it is the right thing to do. However, while the "common wisdom" is that you should have no more than 10% of your portfolio in your company stock, my opinion is that the risks far outweigh the benefits and the smart strategy is to sell, sell, sell.

1 comment:

plonkee said...

I was the recipient of a rather large bonus in the form of stock in the company I work for. I promptly sold it as soon as possible. Since then the stock in the company has gone up by about 25%.

When my colleagues ask if I made the right decision, I tell them that of course I did. Because I definitely made the right decision.