Many employees have an affinity for their company stock, and at first glance this might seem to make sense. Who knows the company's prospects better than its employees? If you have pride in your employer and believe it will be successful, the desire to own company stock can be strong.
However, we have always counseled our clients on the potential risk of having too much invested in their company stock. After all, their financial lives may already be heavily tied into the company's success based on their wages, bonuses, profit sharing contributions, etc. Do you really want to put even more eggs into that same risk basket by loading up on company stock?
But there is more to it than that. The fact is that most individual stocks (and every stock is someone's employer stock!) will not outperform the stock market. A JPMorgan study1 covering 1980-2014 concluded that about 2/3 of the stocks underperformed the Russell 3000 index over the period. Even worse, 2/5 of all the stocks lost money despite the long holding period!
Even more recent research2 from this year shows that more than half of stocks since 1926 underperformed U.S. Treasury Bills, one of the safest and lowest returning assets you can buy. Since 1926! How is this possible? Don't we all know that stocks have dramatically outperformed T-bills over long holding periods?
Well, the answer is yes and no.
Yes, the stock market has done very well as this represents the aggregate performance of all stocks, winners and losers. But no, as it turns out that any given stock will have returns that vary dramatically from the market. But still, how is it that so many stocks can perform poorly and still have the stock market do well?
The answer is that a relatively small number of huge winners provide a substantial portion of the market's long-term return. Out of over 25,000 stocks analyzed since 1926, just 10 companies have produced 16% of all the wealth creation in the stock market (e.g., Exxon Mobil, IBM, Wal-Mart.) And 75% of the cumulative wealth creation came from just 282 stocks, a little over 1% of the total number.
Just consider Apple and Amazon over the past 20 years. Both stocks have gained more than 20,000% over this period, turning $1 of investment into more than $200 of gains. In comparison, an adept (or lucky) stock picker who managed to gain 10% per year (handily beating the market) would have seen $1 grow to a little under $8.
So what can we make of all this? What you'll hear from Wall Street's active management firms is that this is great news because their stock pickers are working hard every day to identify just the winners and avoid all of the losers. Unfortunately, history has shown that this endeavor fails more often than it succeeds, primarily due to the higher costs incurred. The other thing to consider is just how likely is it for a stock picker to hold onto one of the stocks long enough to achieve the massive returns? Very few investors hold onto a stock for decades and every stock goes through gut-wrenching drops over time that will test your tolerance.
Our conclusion is that it reaffirms the logic for a passive, low-cost investing approach. We humbly admit that we are unlikely able to pick the small number of firms that will drive the majority of market returns over the coming decades, yet we can still participate in their growth by owning broadly diversified stock funds.
So, back to the topic of buying company stock (or stock picking in general) – does it still seem to make sense? You may be right that your company is better than average, but as we've learned, that's not enough! Why take the additional risk when you may not earn any additional reward?
1 The Agony and The Ecstasy: The Risks and Rewards of a Concentrated Stock Position. J.P. Morgan
2 Do Stocks Outperform Treasury Bills? Hendrik Bessembinder