Nobody Knows What Will Happen to an Individual Stock
When I’m asked for investment advice and I say “nobody knows what will happen to an individual stock,” I almost always get nodding agreement, but these same people then act as if they know what will happen to their favourite stock.
In a recent case, I was asked for advice a year ago by an employee with stock options. At the time I asked if the current value of the options was a lot of money to this person, and if so, I suggested selling some and diversifying. He clearly didn’t want to sell, and he decided that the total amount at stake wasn’t really that much. But what he was really doing was acting as though he had useful insight into the future of his employer’s stock.
He proceeded to ask others for advice, clearly looking for a different answer from mine. By continuing to ask others what they thought about the future of his employer’s stock, he was again contradicting his claimed agreement with “nobody knows what will happen to an individual stock.”
Fast-forward a year, and those same options are now worth about 15 times less. Suddenly, that amount that wasn’t that big a deal has become a very painful loss. He has now taken advantage of a choice his employer offers to receive fewer stock options in return for slightly higher pay. It’s hard to be sure without seeing the numbers, but in arrangements I’ve seen with other employers, a better strategy is to take the options and just sell them at the first opportunity if the stock is far enough above the strike price. Again, he’s acting as though he has useful insight into the future of his employer’s stock.
The lesson from this episode isn’t that people should listen to me. I’m used to people asking me for advice and then having my unwelcome advice ignored. What I find interesting is that even if I can get someone to say out loud “I don’t know what’s going to happen to any individual stock,” they can’t help but act as though either they know themselves, or they can find someone who does know.
I had a similar but opposite experience. I previously worked for a highly successful Canadian software company and received a substantial bonus annually, 50% of which was in shares. As such, with the company rapidly growing, those shares quickly became quite outsized relative to the rest of my savings.
ReplyDeleteMy (at the time) mutual fund advisor recommended diversifying. At that point the shares, on average, had 10 x.
The advice was correct, and had I diversified appropriately things would have turned out okay. But I lost my job and I was bitter and made a lot of foolish trades. The original stock went on to 21 x and I lost the vast majority of my money through a series of horrible investments.
I agree that diversifying is critical, and had I stuck to my initial buys of banks, insurers, telecoms and ETFs everything would have been fine. So yes, diversify, but diversify wisely :)
Hi James,
DeleteWhen I give advice to friends or family, it's to diversify widely, keep fees low, and trade seldom. I usually go with one of Vanguard Canada's all-in-one ETFs.
With prices down, it may well be a good time to sell the company stock, bank the loss for later use, and move the cash to a TFSA or RRSP. They don’t necessarily need to switch out of the stock entirely, just “take advantage” of the low prices while they can.
ReplyDeleteLet's reframe your advice into a better set of questions and decision points.
DeleteFirst question -- what is the value of the entire company (shares outstanding x stock price)? Is the value less than what a knowledegable buyer would pay for the entire company? If it is, then buy more.
If you can't answer those questions, why are you investing in individual stocks? Stock investing isn't a casino, but many people treat it like it is. Take Michael's advice and buy index funds if you're unprepared to do the homework.
Doing the homework (hours poring over annual reports and financial statements) is certainly necessary, but I'd take this a step further. In a competition where even most teams of professionals can't add value, individual investors should try to be realistic about their ability to out-trade the best pros.
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