Should You Hold Your Employer's Stock?

If part of your compensation package includes employer stock, you’ll inevitably be faced with a dilemma: should you keep or sell your company’s stock?

Let’s look a few common scenarios:

A portion of your restricted stock unit (RSU) grant recently vested. Now you have company shares sitting in a brokerage account.
You recently exercised employee stock options
You participate in your company’s ESPP, and the plan recently purchased shares.

You think to yourself:

I believe in my company
I love the people I work with
We have a great product-line or service
Management is strong

Sounds like a great idea, right? Hold on a minute… let’s talk about why that might not be a great idea.

Company-Specific Risks

There are many specific risks which an individual company is exposed to. Company-specific risks are different from the risks faced by the overall economy (e.g. recession). Here are some examples:

Improvements in technology make your core product irrelevant (eg film cameras → digital cameras → camera phones)
The visionary CEO gets diagnosed with a terminal illness
Auditors determine that management has been manipulating financial statement information to artificially boost earnings
Company loses its largest revenue-generating customer
Other companies step into the industry and take market share
Company borrows too much money and has trouble making debt payments

Market Efficiency

Markets are becoming increasingly efficient — publicly available information is constantly flowing into stock prices. (Huh?)

The Efficient Market Hypothesis (EMH) is an investment theory originated by Nobel Laureate Eugene Fama in 1970. According to this theory, stock prices reflect all available information. Therefore, consistently outperforming the market with stock-picking strategies is impossible. Note: this theory is highly controversial in the investment management world.

How does this work? Equity analysts (sell-side analysts) spend a tremendous amount of time analyzing companies. They research a company’s: competitive advantages, balance sheet, product/service offerings, growth opportunities, threats, competition, etc. Based on their findings, analysts issue a buy, sell, or hold recommendation and publish a quarterly earnings estimate. This research is sold to institutional money managers (eg pension funds) and then used to make buy/sell decisions in the marketplace. Based on this buying and selling activity (supply and demand), stock prices go up or down — analyst knowledge flows into stock prices.

What does this mean for your company stock? Your company’s expected future performance has already been factored into today’s trading price. Analysts have incorporated assumptions of future earnings growth into their analysis. In order for the stock price to jump up in the near-term, the company would need to outperform the market’s expectations (e.g. company reports higher earnings than analyst consensus expectations).

Competition

This Youtube video illustrates how the largest 15 global companies (by market capitalization) have changed from 1994-2019.

A recent study conducted by consulting company Innosight shows “the 33-year average tenure of companies on the S&P 500 in 1964 narrowed to 24 years by 2016 and is forecast to shrink to just 12 years by 2027.” Essentially — competition is fierce, and it’s very difficult for a company to stay at the top. The global marketplace is dynamic and the landscape can change quickly. Will your company still be a market-leader 10 years from now?

Diversification

The company-specific risks mentioned above can be diversified away by holding a large basket of stocks. For example: the performance of a portfolio of 1000 companies is largely unaffected if one of the companies is found guilty of cheating on emissions testing.

Conclusion

You may be thinking… “What if I decide to sell my company stock and then my company stock crushes it? Won’t I be missing out?”

Is it possible that your company stock skyrockets, dominating the returns of a diversified portfolio? Yes, it’s definitely possible. If you decide to sell all or most of your employer’s stock (to diversify into a broader portfolio), it won’t feel good if the stock you sold skyrockets. This is especially true if many of your coworkers held onto their shares after you decided to sell.

So how do you find the right balance? Determining whether to hold your employer’s stock (and how much) is a difficult decision. Some things to consider:

your financial situation and goals
debt on your balance sheet
level of liquidity (cash savings)
your comfort level with risk
your employer’s growth prospects: current market share, competition, industry standing
whether you will receive more stock later through future equity vesting rounds. Future vesting rounds expose you to the fluctuations of the stock price

A common rule-of-thumb used by many financial planners is: you should not hold more than 10% of your investment portfolio in any one company’s stock. Speak to a qualified financial professional if you need help understanding the implications of your equity package.