Advice To A Friend On A Concentrated Private Stock Position From His Employer by David Merkel, CFA of The Aleph Blog
From a friend of mine:
About a quarter of my assets are in my company stock. I have been counting this as a stock in my portfolio, but now I am wondering if that might be making my portfolio too conservative. The company is privately held, and they manage the “price”, so that it goes up consistently with the growth of the company. As long and the company does not go bust, this seem to be more stable than a stock fund.
What do you think?
I don’t think you are being too conservative. Count it as stock. Here’s why:
Don’t look at the price, on the first pass. Consider the underlying stability of the company. Here’s a way to think about it: if the company borrowed money over the intermediate-term from a bank, or floated a bond, what kind of rate would they pay? Would they be considered investment grade, and pay a low interest rate, or would they be more like a high-yield bond, where both the covenants on the debt and the yield paid are significant.
If it would be an investment grade lending risk, you might be able to think about it as partially stock and partially a bond. If not, then stock. Regardless of how you think about it, you have to realize that you are running a concentrated risk here, and play everything else a little safer as a result.
Now, the stock price that they quote to you does have a meaning, which varies based on what your employment plans are with your firm. If you are thinking of leaving, you would like a high price to get cashed out at, but if you are thinking of staying, you would probably like a lower price, as you may get more shares.
I don’t know everything here, so my advice is general. It would change if you could buy or sell with discretion, but that is not likely. If you have some idea of how upper management views the long-term prospects of the company, that could guide your reasoning. As an analogy, consider the investment banks on Wall Street prior to their becoming publicly traded. Management viewed their ownership in the bank as part of their pension, so they shot down ideas that were too risky. They were happy to see the value of the firm grow at a reasonable rate with near-certainty, rather than a rapid rate with a moderate probability of failure.
So, think about your management team and what they do. Make discreet inquiries to them if you think it is wise. Be careful with the rest of your assets. How careful depends on the soundness of the firm, your risk tolerance, and your time horizon for when you will need to convert the assets to another form for your own use.