General Electric has been an American corporate success story for generations. Founded by Thomas Edison in 1889, GE has symbolized American business drive and ingenuity. It’s this history that makes GE’s spectacular fall from grace so shocking. After years of bad judgment and decision-making, the company is in shambles and it’s stock has suffered a 75% collapse in the last two years. The longer-term performance has been even worse, with GE stock down 85% from it's all time high in 2000. There are many lessons to be learned from the events at GE, but I will focus on two personal finances ones.
A first lesson is not having excessive exposure to your employer’s stock. In looking at prospective client portfolios, it is not unusual to find inappropriately large concentrations in company stock, either public or private. The combination of receiving compensation in stock, coupled with options and RSUs, and discounted stock purchase plan, year after year, can conspire to create a large concentration. An employee already has a high degree of financial dependence on his company, primarily through income, but also through benefits like health insurance. To magnify this by having a large position in the company’s stock materially heightens this dependence and increases financial risk.
We’ve all heard the success stories such as the executive assistant who started at Google at its founding, was paid mostly in stock and retired fabulously wealthy. That’s great. But what about the experience of long-time employees of AIG or Bear Stearns in the financial crisis, or more recently, employees at GE. Before the recent stock collapse, GE’s 401K plan had nearly one-third of plan assets in GE stock. The perception that the stock was stable and conservative coupled with an appealingly high dividend leads me to believe that many GE employees likely had very large allocations to the stock. They’re not alone. Consider Enron’s 401k plan in 2000, the year before the it’s bankruptcy. An astounding 60% of plan assets were in Enron stock.
I personally recall hearing friends and colleagues at various highflying financial firms who had enormous allocations to company stock in 2005, 2006, 2007. Many openly bragged about how much of their net worth was in company stock, and how sound their judgment had been for not trimming. In the subsequent financial crisis, however, many of these same people lost their high-paying jobs. The financial stress was made considerably worse by the fact that the large allocation to company stock had now devastated their net worth and severely impacted their financial security. Ten years later, many still haven’t financially recovered.
How much concentration is too much? That is too nuanced and complex a question to answer with a blanket number on a blog. Only when looking holistically at a client’s financial picture, can a proper exposure be determined. Regardless, anybody with more than, say, 10% of their net worth in company stock should be looking into their options and talking with an advisor.
The second point I take from GE is a lesson in how not manage your balance sheet and investing. Once a sterling AAA credit with a conservative balance sheet, GE, grasping for short-term growth, dramatically leveraged its balance sheet in the lead-up to the financial crisis. The company bought back billions of dollars in highly-valued company stock and made several large acquisitions, all in the quest for near-term earnings growth. When the crisis hit, GE’s short-term orientation and imprudent financial behavior forced it to take dramatic action to shore up its precarious balance sheet. The company sold billions of dollars of depressed company stock to the public near the lows. It was a textbook example of buying high and selling low.
The lessons are simple, but hard to stick with: Don’t chase short-term performance, focus on the long-term, be financially conservative-particularly in good times, and have a patient and sound investment philosophy that strives to buy low and sell high. GE was led by very smart and very capable people who nevertheless could not control their emotions and be disciplined. Make sure you aren’t making some of these same mistakes in your financial life.