Microsoft announced layoffs today: the stock dropped about 11% in one day, and is about half of its 52 Week High Price.
It is not easy to get employed at Microsoft, and one can easily understand why. I am sure that a lot of Microsoft employees own Microsoft stock, and some of them must own quite a bit of it, as a percentage of their total assets.
I personally know a lot of people, who started investing in the stock market by buying their employer’s stock. People feel secure in their employer, and when starting off – on a risky investment such as stocks, prefer their own employer to other companies.
Buffet Insured a Billion Dollar Lottery
Several years ago – Warren Buffet’s – National Indemnity Insurance – insured – Grab.com’s – 1 billion dollar lottery prize money. The odds of someone winning a billion dollars were: 1 in 2.4 billion, and if someone won, the cash would be disbursed in a number of years (as opposed to lump-sum).
National Indemnity insured the prize, got its premium, and no one; won the billion dollar lottery.
National Indemnity entered in a transaction, which had a small probability of a very big loss. And they profited from it.
Get Laid – Off and Lose All your Savings
Unfortunately, for – the Microsoft employees, who invested in their employer’s stocks, and later got laid off, they also – entered in a transaction, which had a small probability of a very big loss, but they lost.
The difference between other shareholders of Microsoft, and laid-off employee shareholders of Microsoft – is the fact that the laid off employees will probably need to sell the stock at a big loss.
Other shareholders can look at their portfolio, curse their broker, and go on with their life; waiting for the market to turn. Their loss is just a notional loss. If you don’t sell your stock, then the loss is just notional – only on paper.
However, if you lose your job, and all your savings are in your company stock – first you lose your pay-check, and then you lose a substantial chunk of your savings. In extreme cases – you may be completely wiped out. (Enron – anyone?)
The worse thing is that, if you are working for a great company, which had to resort to lay-offs, the market situation must be quite dire, and you may not find another job that pays the same – for a long time.
Don’t buyÂ your employer’s stock
This particular risk is very hard to visualize, and only when it happens with someone you know – you comprehend the magnitude of it.
The Satyam Fiasco (India’s Enron) happened in the recent past, and I know a lot of people who lost their jobs and their savings, and I suspect the Microsoft lay-offs will have the same kind of impact (but a lesser magnitude) on a lot of people.
Everyone has a different risk tolerance, and everyone views risk differently. A lot of people who got employed in the IT Sector, after the dot com bust played out, have a completely different notion of job-security, than people who saw the dot com bust.
To me – a small probability of an event that can wipe off your life’s savings, is a risk that is simply not – worth taking.Â Especially, when the trade-offs are not very clear. If I am a Microsoft employee, and think Microsoft is going to do extremely well, the question in this context is – will it do substantially better than Google, IBM or Intel? Is it worth taking this risk?
You might think – What if I invest in IBM, and IBM goes bust at the same time that MicrosoftÂ lays me off?
It could very well happen, but the odds are lower.
But Buffet did it, didn’t he?
When I was discussing this idea with a friend – he cited the Buffet deal. However, the difference is that National Indemnity is an insurance company, and it is the job of insurance companies to get into such deals. They understood the risk that they were taking, and knew how to put a fair price on that deal.
Most investors, who have not seen lay-offs – probably do not understand this risk at all, hence don’t factor it in while making their investing decision.
We are going through one of the worst recessions most of us would live to see, and, whatever else it may be, it is a heck of a teacher. I don’t know whether this recession will give us the answer to the question of buying our employer’s stock. But, I would certainly think – that it has at least given us the ability to ask this question, and see the situation in a new light.
I have been thinking about this question for about a week now, and am really curious to know what others think, so please, do leave a comment.
6 thoughts on “The Small Probability of a Very Big Loss”
@Ancella: Thanks for commenting. I agree that people who hold the stocks and are able to hold on to them should wait a bit and see if they can salvage something out of it.
@Sri: I think more investors should take a leaf out of your book and do the same thing as you are.
@Chip: Pfizer can pretty much forget about new patents now.
@VC: The lesson is a hard one to learn, and I personally think untile people lose a bit of money, they don’t learn this lesson.
People need to learn that stocks come with a lot of risk in the short term. Over the long term stocks perform quite well, but if you are investing in the market you need to know that the market goes through cycles and that your investment is going to go up and down. People get greedy when the markets go up, so many people double their money in stocks but keep holding on to it. If you have doubled your money, sell it! No stock is going to go up forever, if the stock has skyrocketed, it is bound to eventually go down. So by getting greedy and hoping it goes up even more, you also increase the risk that it is going to go down. Only buy your employers stock knowing that there will be times when your investment goes down. If you cannot afford to lose any money, then do not be in the market to begin with. It can be risky! Only take stock from your company if you can afford to lose it.
You are right! Everybody are sending people home. If Pfizer can layoff 800 scientists, I just could not believe how a drug company who’s major and business by drug patents would come to still. How are they going to do business?
We are going to witness the worst job losses in the history and the domino effect is seen all over the world.
The wise thing to do in case of any stock, whether company or otherwise: Take out the initial money invested by you in the stock by selling a portion of stocks. Many do not realize that it is important to take out initial money, which is most likely your hard earned cash or high cost loan.
Next time onwards, that is for future stock purchases, always rotate, that is sell more of the balance stocks to buy more. In case you are investing your hard earned cash, then take that money out as explained earlier.
It is the only way to ensure that your net worth never becomes zero because of “crook stocks”
Well, if it were a couple of years ago, with the market reaching new heights, I would have definitely invested in my employerâ€™s stock. But with the current situation, it would have seemed wise to sell off any company stock I had earlier, as soon as this recession started out, in anticipation of cutting losses. After all, I wouldnâ€™t want to own my companyâ€™s stock when its worth a portion of what it was before, with no near hope of it recovering. I know of people who have a good portion of their savings in Satyam stock. But they are holding on to it as of now, as they canâ€™t really afford to lose so much at this stage, in the anticipation of it going up in case of any merger / take over.