Retelling the Story of Concentration Risk

My wife and I were both very fortunate to have inherited some money. When we got married, almost 19 years ago, we found out that about 10 percent of our combined net worth was in General Electric (GE) stock. It was the largest position for both of us, actually.

I received the stock when my grandfather died, which was right around the time that Jack Welch took over as the CEO.  Since the stock was up about 4,000 percent under his tenure, the cost basis was pretty low compared to the value when we got married.

That was nothing, though, compared to my wife, whose grandfather had given her the stock when he was alive.  As a result, her cost basis was just five cents and dated back to the 1940s.

The advice that we had received, however casually, was that we could never sell the stock because the tax bill would be too big.  As a result, we hung onto the stock for the few first years of our marriage.

When I decided to join Chris and Dannelle at Acropolis (before it was actually Acropolis), Chris said that I had way too much GE stock and that we should cut it down.  I protested, telling him about the cost basis and the taxes, and he told me to ‘belly up to the bar and be happy that you’ve got those gains to pay taxes on.’

So, I decided to sell it over the course of a few years.  Since I’m writing this at home, I don’t have the exact data (and I probably couldn’t share it for compliance reasons), but I can assure you that it was excellent advice because I got lucky and sold right as the leadership at GE went from Welch to Jeff Immelt.

Immelt was unlucky in that he took over two days before September 11th, when planes with his engines hit towers that he insured.  Then, a few years later, the 2008 financial crisis hit the money division that Welch had built.

It wasn’t just bad luck, though, Immelt is famous for his inability to both give or take bad news and GE’s businesses struggled under his leadership.  He sold a lot of assets and bought back a lot of stock, but it wasn’t enough – the GE stock was lower when he left last year than when he arrived in 2001.

And then, the news for GE got really bad.  Like most new CEOs, John Flannery decided to clean house and start fresh.  It’s a good strategy because, if they do it right, the stock will recover in the coming years and they’ll look pretty good.

The ‘big bath’ theory, as it’s known, has been much more of a bloodshed than usual: since Flannery took over, GE stock has lost about $140 billion in market capitalization (about half of its value), which is more than Valeant a few years ago, Lehman Brothers and Bear Stearns put together in 2008, or Enron way back in 2001.

Over the last 15-years the total return on the stock is -0.3 percent annually, while the S&P 500 earned 9.80 percent.  That means that GE shareholders made well less than inflation while the rest of the market tripled.

Thanks to Chris, I didn’t suffer any of that.  Neither of us had any idea how GE would have fared – I never would have guessed that it would have done this badly.  Maybe you could argue that I wouldn’t have lost any money (and saved the taxes), but the opportunity cost was very high.  I think those tax dollars were some of the best money that I’ve ever spent.

The Wall Street Journal ran an article yesterday about some of the GE workers who spent their entire career there that now have to go back to work because of the stock price (click here for the article).

The article is full of sad stories of workers who thought that they were doing the right thing only to find out about the perils of concentration at the worst point in their lives to take that kind of risk.

I feel like the story of workers over concentrating in their company stock is so often told that it’s not worth telling again.  This article reminds me that these kinds of old investment truths need to be told, retold and then retold again.