Your Stock holding in employers company : Good or bad

My readers will call me mad if I don’t mention Enron here in this topic so I am going to write about it.

Once most innovative company in USA, Enron was Energy Giant and market darling. Yes they were so much innovative that the company innovate new way to represent Financial reports, innovate new ways to wipe out wealth of investors, innovative ways to wipe out employees Retirement money.

It all started with Enron Online (EOL) an exchange like structure where you can trade on energy. For every trade, Enron was either Buyer or seller. In today’s era, clearing Houses don’t take such risk and search Counter Party. First mistake.

By mid 2000 EOL was executing nearly $350 billion in trade. At starting point of  Dot-com bubble burst, they were exposed to most volatile part of Market. By the fall of 2000, Enron was starting to crumble under its own weight. CEO Jeffrey Skilling had a way of hiding the financial losses of the trading business and other operations of the company; it was called mark-to-market accounting. This is a technique used when trading securities where you measure the value of a security based on its current market value, instead of its book value. This can work well for securities, but it can be disastrous for other businesses. In Enron’s case, the company would build an asset, such as a power plant, and immediately claim the projected profit on its books, even though it hadn’t made one dime from it. If the revenue from the power plant were less than the projected amount, instead of taking the loss, the company would then transfer these assets to an off-the-books corporation, where the loss would go unreported. This type of accounting enabled Enron to write off losses without hurting the company’s bottom line. The mark-to-market practice led to schemes that were designed to hide the losses and make the company appear to be more profitable than it really was. To cope with the mounting losses, Andrew Fastow, a rising star who was promoted to CFO in 1998, came up with a devious plan to make the company appear to be in great shape, despite the fact that many of its subsidiaries were losing money. ( Credit for Enron story goes to Investopedia)

First of all, Why this is issue? Why you need to think about it twice? Whats wrong in investing with your employer?

The reason is your employer is source of your income. When you are employed with your employer, there is always risk that your employer may go out of business. If your employer is Govt then its not for you.

Why you are investing Money? For many reasons. One is for retirement. For this goal, taking risk in early age is good but when it is unnecessary risk, it is not advisable. Like investing in Penny stocks. So when you are investing for retirement, you supposed to take less risk or diversification is one reason for your investment.

So what is happening when you are investing in your employer company? You are taking more risk. How?

There is always risk that your employer will go out of business. Yes. Even Goldman Sachs, Bank Of America was under risk. Lehman Brothers Shutdown. AIG fell Drastically.

So by investing in your employer company, you are taking heavy risk. Even if you are investing for Say buying car. You investing in your employer company and suddenly it may FAIL.

Yes I agree that failure is visible to employees first so it’s difficult. But how it was possible that Lehman Brothers employees can’t see the future even week earlier? JP associate failed even though holding large chunk of assets and even if they were one of the largest company. Two of India’s biggest airport makers GVK and GMR also felt worst time. Reliance communication once called best buy among Indian capital market also feeling heat and possibly need to sold large part of business. There is always possibility that in next 10 or 15 year, Some large crisis will come.

Why I am taking it specifically in case of retirement? The reason is after retirement, your investment is single source of income for you. The time frame is long. As nature of Market is very cyclical, you are exposed to some amount of risk.

In that case if you are adding more risk by concentrating your exposure to your employer, how can you handle scenario in which your investments are not sufficient for you to take care of your retirement.

Forbes magazine, in one of their Article call stock of your employer is Most risky stock and I agree with it. It all matters when it come with Correlation of return. Where theoretically, Correlation of your salary and return of of employer stocks are correlated.

Now I need to talk about some special cases.

  1. ESOP : Very good thing. But that does not mean you start keeping large chunk of it. its always good to diversify.
  2. 401k : By default you have option to choose. there is no one telling you to invest only in your employer stock.
  3. Mutual funds, other type of Retirement plans : Defined benefit plan, here its not your responsibility to take risk. fund managers are professionals. They know how to handle.

so it means that the issue is only with your personal portfolio.

my advise is treat it as little more risky. Expect little more return. Track analyst report on this investment closely. If you see any type of red flag, reduce or sold it.

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About Ashutosh Tilak

Tracking Indian Capital Market since 2010. Finance Student, On this blog I am writing about finance and Investing. You can contact me analystashu@gmail.com or @androidashu & @InsideFinanc on twitter