February 26, 2021

Below is a transcript of the video interview.

Kristin Sun:

Welcome, everyone, to another episode of the Sand Hill Interview series. I’m Kristin Sun, Senior Wealth Manager and Shareholder here at Sand Hill. And I’m joined by my colleague, Mark Strahs, Sand Hill’s Co-Chief Investment Officer and Shareholder. And we’re going to discuss today’s topic: Why it’s time to manage your company stock before it manages you.

Mark Strahs:

Hi, Kristin. Thank you for the invite.

Kristin Sun:

Thank you for joining me, Mark. So Mark here has nearly 30 years of financial markets experience with a focus on analyzing individual stock fundamentals. Mark is also Head of Equities here at Sand Hill which includes responsibility for managing the firm’s core stock portfolio.

If you’re watching this video, you’re probably holding onto a large position in your company stock which has either come from you building a business from scratch, or you’ve received it as part of your employment compensation package.

Today, we will address two important topics. First, how stock concentrations have become a huge driver of wealth today. And second, the importance of diversifying away from stock concentrations, allowing you to manage your stock before it’s too late.

Mark, can we start with hearing your views on the recent IPO activity and how that has resulted in a surge in single stock wealth for employees?

Mark Strahs:

Sure. Well, we’ve been in a very healthy environment. The new issue market has seen tremendous volume and in multiple formats, including initial public offerings, otherwise known as IPOs, direct listings and of recent, quite a few of the special purpose acquisition companies, otherwise known as SPACs. And highlight the stage was set back in 2019, we had numerous long-awaited IPOs come to market, names we know well, including Uber, Lyft, Pinterest, and Beyond Meat. We then had a bit of a COVID pause leading to the second half of 2020. There was quite a resurgence, again, of well-known names, such as Palantir, Snowflake, DoorDash, and of course, Airbnb. These highly anticipated and very successful deals built a bit of a frenzy in the market with many investors essentially tripping over themselves to chase new fresh deals with fresh capital in hopes of finding the next Tesla. What I point out is typically, when we see this activity, it means we’re near the top of a cycle. We just don’t know when the party ends.

Kristin Sun:

Recently, you authored an article on the IPO market and equity compensation highlighting a concept that you coined the F.A.M.E. or F.A.M.E. Principle. Can you help the viewers understand what that is and why it’s crucial to avoid falling into the trap of invincibility?

Mark Strahs:

Sure. I was trying to create a useful acronym to remind individuals with stock-based compensation plans that the benefits derived from the bull market shouldn’t be underappreciated. Chance favors the prepared mind, and those with large concentrated equity positions need to manage their vested stock exposure just as they manage their career. For those fortuitously aligned with company stock, don’t get caught in the misconception that the same pace to stock appreciation would necessarily continue nor that the value of existing stock won’t erode. That could be an error. 

Overall, I’m trying to provide insight that those with large holdings of employee stock, that the same effort applied in a less robust stock market most likely might not have driven the same reward. Rather than ignore that markets can and will be volatile, consider taking a few chips off the table. Re-allocate your hard-earned capital towards building a diversified portfolio which might better stand the test of time.

This period really is compared mostly to the late 1990s. At that time period, it was pretty helpful to use the quote, “Don’t confuse brilliance with the bull market.” So whereas patience is certainly rewarded when fundamentals dictate the market might be in a trough, one needs a different mindset when the broad indicators illustrate we could be closer to the upper end on historic measures.

Kristin Sun:

Interesting. I personally found this quote from your article really compelling, “Persevering the financial benefits of one’s sweat equity is just as important as building the career that set the path.” And to our viewers, if you’re interested in reading Mark’s article on the F.A.M.E. Principle, click the link here.

Now, how should an investor factor in the risk of their single stock in the context of their broader investment portfolio?

Mark Strahs:

Sure. Well, it’s not unusual that your employee stock might be the majority of your net worth in the early innings of your career. What we often recommend in a client consultation is that over time, a single stock shouldn’t be larger than 25% of the entire portfolio. Numerous inputs factor in the decision, including age, capital gains within a tax bracket, and of course, the expected path of the underlying company. By all means, one size does not fit all. Now, if you don’t have a broad portfolio outside your company stock, you can’t derive your targeted concentration percentage. Hence, we suggest one consider using a portion of their vested company’s shares as feed stock to build that portfolio. Just as one should contribute to a 401(k) to take full advantage of your employee contribution, one might consider it a parallel exercise where you are occasionally trimming against your position during open trading windows. I’d highlight we rarely recommend large liquidations, but do suggest having a system in place for the dual purpose of diversifying while building your investment nest egg.

Kristin, perhaps you can share with us some insight into how you approach diversifying away from company stock with your own clients.

Kristin Sun:

Sure. I’d be happy to. I strive, really, just to simplify the overall equity picture in a really digestible format. It helps my clients eliminate the added stress that often comes from navigating their company’s online equity portal. I’m also a bit of an Excel nerd, and I found that my clients really appreciate seeing all of their equity components in one place. That’s RSUs, non-qualified stock options, incentive stock options, ESPP, and performance stock units. Those are some of the more common forms of equity compensation.

Through this equity dashboard, I include the estimated tax consequences of selling short-term versus long-term. And often, I consult with the client’s tax professional to make sure that the numbers we’re looking at are accurate. Once that is all constructed, I test out the impact of selling at a range of prices, allowing my clients to clearly understand the potential tax ramifications and estimated net proceeds they could receive from each scenario.

Finally, Mark, as you know, I partner with you and our investment team to help clients understand how Wall Street views their company, as that can differ from their perspective within the company. That way, we can incorporate your insights into the decision-making process.

At the end of the day, each of my clients has their own long-term goals in mind, and I help them better understand how taking these steps to diversify will help them achieve those goals.

So Mark, before I let you go, are there any final thoughts you’d like to share?

Mark Strahs:

I would just highlight that we aren’t robotic when it comes to managing stock positions. We run in individual equity strategies, so individual stocks are a big focus at Sand Hill. When managing concentrated equity positions, we monitor the companies and their peer group, listen to the conference calls, really track the fundamentals to make sure we have a good sense and an opinion and when to consider trimming against a holding. As it relates to freely tradable stock, not restricted by employee trading windows, we do also consider other processes, including using option strategies and exchange funds to help in the diversification. What we try to avoid is reducing exposure based on emotional reactions when a stock might be under excessive pressure for the wrong reasons.

Kristin Sun:

Absolutely. That really speaks to me. I have many stories of over-stressed clients who’ve turned over the reins to Sand Hill once they’ve experienced, really, helped painstaking it was watching their stock all day long for days on end during those open trading windows. Even when they didn’t intend to, they just gravitated towards watching the stock price. And this was all while trying to do their actual job. From my perspective, the relief they felt knowing that we were watching out for them, that was palpable.

Well, Mark, I want to thank you for your time and your insights today. To get in touch with either Mark or myself to discuss your unique stock concentration strategy, click on the link.

Thank you for joining us for another edition of the Sand Hill Interview series.

*****

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