By Guest Blogger Doug Rowat
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WeWork’s former CEO Adam Neumann is, pun intended, a piece of work.
The pot-smoking, Maybach-driving, personal-trainer-punching CEO almost singlehandedly decimated WeWork’s chances of a successful IPO in 2019. Some of Neumann’s excesses included using US$13 million in company funds to invest in an artificial-wave pool company, financing former professional surfer Laird Hamilton’s “functional mushrooms” health food venture and spending US$60 million on a corporate jet that was often used to take his family to surf spots around the world. See a theme? Yes, Neumann is a surfer dude.
Unfortunately, he apparently wasn’t much of a chief executive. Eventually, the corporate bankers and venture capitalists realized that his erratic behaviour and lack of real management skill was sinking the company and, with the help of SoftBank, they arranged his ouster. Unfortunately, it cost billions including a US$725 million personal payout to Neumann himself.
Sadly, according to the Wall Street Journal, the deal effectively made worthless stocks and stock options for about 90% of the company’s employees. A WeWork senior executive bluntly told The New Yorker: “The employees got screwed.”
WeWork’s disastrous example aside, owning company stock isn’t necessarily a bad thing. In fact, I recommend it to most of my clients because the favourable strike prices (or other pricing discounts) and/or employer matching often make owning company shares a compelling investment. However, concentration risk is always the danger.
While management fiascos (or other economic or operational catastrophes) are uncommon, they do happen. Just ask Enron, Lehman Brothers, Bear Stearns, Sears, Encana, Nortel, Bombardier, BlackBerry, Bear Stearns or General Electric employees.
General Electric, in fact, provides a particularly useful case study. In 2016, General Electric stock represented more than one-third of the company 401(k). Unfortunately, just one year later the company struggled. In 2017, operational issues and particularly weak results from its power generation business resulted in a massive 50% cut to its dividend and ultimately to a spectacular 45% drop in its share price. What made this drop even more stunning was that it occurred in a year when the Dow Jones Industrial Average actually gained 25%. It’s a pretty safe bet that if your company’s share price plummets this dramatically in a non-bear-market year that it’s unlikely to recover quickly, if at all. And, indeed, GE’s share price has never recovered.
I prepared the chart below to illustrate how otherwise balanced and diversified portfolios can be negatively impacted by a 45% decline in a single-stock position. If we assume a year where the portfolio’s balanced component returns 7%—a healthy gain—zero downside protection is provided if this portfolio also includes a plummeting single stock at even just a 20% weighting. The chart also gives you a sense of the hole that many of these over-concentrated GE employees dug for themselves.
Outsized impact: if a single stock drops 45%, an otherwise balanced portfolio still suffers significantly.
Source: Turner Investments; Assumptions: a $1 million portfolio with a 7% gain for the balanced component offset by a 45% loss for the single stock
Remember also that in addition to owning your company’s equity, you also work there. A declining share price’s not only bad for your finances, but it’s probably also bad for your job security. You’re effectively doubling up your risk. Needless to say, as GE’s share price plummeted in 2017, tens of thousands of workers were subsequently laid off.
Further, maintain perspective on your company’s size. You may love the particular department that you work for and believe that your department’s indicative of an overall well-run company, but recognize your department’s relative size. Big picture, your department probably doesn’t amount to much. Unless you’re actually senior enough to sit in board meetings and are privy to detailed, high-level internal information, you don’t, in fact, have any larger perspective or insight into your company’s actual fortunes.
So, the advice?
Keep company equity exposure below 10% of your overall assets. Schwab Stock Plan Services conducted a survey in 2018 which indicated that US employees with access to company stock options and employee stock purchase plans have about 29% of their overall net worth tied up in these assets. Consider if you fall into this category. Then examine my chart above. Your downside risk is excessive. When you get the opportunity to redeem shares or exercise options, rotate these funds into a balanced and diversified portfolio.
Finally, you may also read favourable press about your company, which may further tempt you to increase your stake in it.
But this favourable media attention, while comforting, is also worthless:
Would this face lie?
Source: Google Images
Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.