How Many Eggs Do You Have in Your Employer’s Basket?

Everyone has heard the old axiom “Don’t put all your eggs in one basket”, which certainly rings true in many aspects of life. Of course, the financial industry dressed up that wise old saying with fancy terms like “diversification” and “asset allocation” in an effort to appropriately advise clients to maintain a risk-appropriate balance across asset classes.  But as I’ve stated in prior blogs, I believe clients are best served by expanding the view of families’ entire portfolio, beyond stock, bonds, mutual funds, etc.  I believe we need to consider a families total exposure to their employer in terms of income AND stock ownership.  Why?  Because there are two big risk-factors that most people don’t consider when they have a disproportionately high weighting to their employer stock.  These are:

1)      Correlation to the Broader Stock Market (a.k.a. systemic risk)

2)      Individual Company Risk

Before we dig into the details on these two risks, I want to qualify a few things.  First, the risk scenario is most acute when folks are use employer stock (or any individual stock) as a savings account or a “rainy day” fund to cover near term emergency expenses.   Second, many of the stock ownership programs (options, grants, restricted stock) are generally a good deal for employees. For example, when a company offers a 15% discount to purchase company shares (employee stock purchase program), that’s something families should seriously consider.

retirement nest makeup

But, the overarching theme here is that families should keep a sharp eye on how much exposure they have to their employers stock and be more vigilant on re-balancing this particular exposure whenever possible.  Income is already critical piece to funding the monthly household expenses, there’s no need to “double-down” on company stock.

So now let’s drill down into the two risks I have identified.

Correlation to the Broader Stock Market:  While a Company’s long-term operational performance is usually reflected in the long term performance of the shares, there can be nightmare scenarios where this is just not the case in the near term.  This could severely dent a family’s balance sheet, sometime irreparably.  Now, some may be expecting me to cite some cyclical boom-and-bust companies reliant on the economy.  That’s too easy. Even “safe” companies can be affected, despite solid track record of performance.  To make my point, on the risk correlation to the broader market, let’s take a look at a “safe” company like Coca Cola (NYSE: KO).

I’m putting my former equity analyst hat on here so please pardon the analyst-speak for a paragraph or two.  As indicated in the grey shaded circle in the chart below, Coca-Cola seemed to have endured the Great Recession without much of an operational problem if we looked simply at what I consider to be a good indicator of performance, operating cash flow.  During the years of the Great Recession, operating cash flow (and revenue) grew in 2008 and 2009 without much of a problem demonstrating the resiliency of the company’s business model.

However, you can see that when the broader stock market was impacted by the fears of a financial collapse in 2008 and 2009, Coca Cola’s stock DECLINED about 24% (from 12/31/07 to 12/31/08), despite the fact that its cash flow and revenues INCREASED in both 2008 and 2009.  Why did this happen?  Because the uncertain environment prompted a sell-off of equities as an asset class in a “shoot-first-ask-questions-later” trading environment.   It didn’t matter that the Company was performing relatively well, no one wanted to own stocks.

Blog Chart Oct 2013

My point is that if you were an employee of Coca-Cola and had a large portion of your near-term assets tied up in the Company stock, it wouldn’t matter how the company is doing if there’s a broader sell-off in the stock market. Now of course the market and Coca-Cola stock have obviously recovered but it’s easy to be comforted now that we know what the rest of the chart looks like.    It may not be so comforting if you see a large chunk of your portfolio down 20+% within a year.

Individual Company Risk: Again, I am calling on my prior experience as an equity analyst where I would drill down into every company I covered in order to provide investing insight to my institutional clients.  Along those lines, one of the first things I would do when an annual report (10-K filing) or quarterly filing (10-Q) was published, the first thing I would do is run a search on the PDF for two terms:  “Department of Justice” and “subsequent events”.  Why?  Because I was looking for a disclosure by a company they are under investigation or they had some material “subsequent” event like an environmental issue or a lawsuit or some kind of fraud investigation.  These types of disclosures (and issues) can materially impact a stock price in the near term or the long term, depending on the issue.  But they have nothing to do with sales, profitability or other operational metrics that typically drive the performance of a stock.  This type of risk, while rare, is still legitimate in my view and another reason why families with any over-weighting to a particular stock need to be aware of just how much they are rolling the dice.

To wrap up, I believe families should take advantage of beneficial programs related to employer stock in most cases.  However, I believe folks need to stay vigilant on exactly how much they are exposed to a single company and should appropriately re-balance as soon as the program rules allow.  Remember, your wages from this company are already supplying a large percentage of your monthly cash flow.  Do you really need to double-down in your portfolio too?

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