Investing in Your Company Stock? Look Before You Leap

We recently discussed why too much love for your company could be disastrous for your financial future.

We looked at lessons from Enron and our very own Satyam where employees who invested in their company stock saw their savings go down the drain.

We also studied why even when your company might not be the next Enron or Satyam, you must not go overboard with your investment in its stock.

But we also suggested that you may have 5-10% of your financial investments invested into your company stock.

Now the question you may have is this – “How do I know whether my company’s stock is worth buying?”

Let me tell you that this is a good question as not many would ask it assuming that they already know a lot about their companies and are thus not required to study them further.

But the fact remains that when you plan to buy any stock – even if it’s your company stock – you need a clear understanding of the opportunity and risks.

In this post, let us discuss two factors you must keep in mind before investing in your company stock.

See, if you want to invest in your company’s stock, you need a good reason.

These two factors can help you know whether your company is really worth investing into.

1. Are the insiders buying?
Insiders are your company’s officers and directors, as well as those who own a large part of your company’s stock.

Being insiders, they are in an enviable position when it comes to knowing exactly what’s going on inside your company. But this doesn’t mean that they can utilize this information to buy or sell your company stock at will.

There are specific rules for insider trading that these senior people in your company must follow. Of course there is a history of malignant insiders indulging in trading on their company shares using confidential information, but such insiders have been brought to task by the stock market regulator, SEBI.

Anyways, insiders can buy and sell company stock, within legal guidelines, and they must disclose those transactions to the stock exchanges.

For instance, you can see what Infosys’ insiders have done recently by vising this page on BSE’s website.

Anyways, let me also warn you that insider selling may not tell you much. Insiders can sell for many reasons, such as to buy property, or raise cash for kids’ education.

For instance, news reports suggested in March 2009 that Bharti’s CEO Manoj Kohli had sold his company shares. While the stock markets reacted to this news and Bharti’s stock took a hit, people failed to read Kohli’s clarification that he had sold his shares just to collect money to buy a house.

However when you hear an insider (or a few of them) in your company selling his shares and fails to offer a reasonable clarification for such a sale, this must serve as a warning message that something might be wrong.

So while you must dig deeper to know why the insiders are selling, you should pay an equally high attention when an insider digs into his or her own wallet to buy shares.

This is because these days most insiders already receive lot of company stock by way of ESOPs or outright grants. Thus, to buy additional shares in the open market, they need to be powerfully convinced of the stock’s prospects.

Anyways, even though insider trading can be a helpful indicator, it’s not a magic bullet.

Like most investors, even insiders could be making incorrect decisions to buy their own company stock. There’s no reason to believe that your company’s insiders are any wiser than other companies’ insiders.

But this is definitely a good pointer for you to decide whether to invest in your company stock or not.

2. What do I know?
One of the most famous investment principles of the legendary fund manager Peter Lynch is “Invest in what you know”.

This holds true when you, as an employee, are looking to buy your company stock. You are looking to invest in ‘what you know’.

You have a good handle on how the company is doing, what its growth prospects are and whether the stock market is treating the stock fairly.

In fact, at most times, you may be faster than an analyst at a brokerage house to recognize when products are flying off the shelves.

But here is a word of warning – you must keep your emotions under control and do an unbiased analysis of your company.

“It’s my company so it must be good” is dangerous thinking.

“I have a great boss, so let me impress him by buying the stock,” is even more dangerous.

Keep aside your rose-tinted glasses, and make an objective judgment whether your company is really the stock you’d love to own.

Read the annual report, and pay close attention to the footnotes. Talk to your accountant (if you know him) whether the company is really making profits on its sales or is it trying to gain market share at the cost of profits.

See how the business is performing versus its competitors. Read any recent news about the company. See how the stock is performing and whether its valuations are reasonable as compared to the business’ real worth.

In simple words, ask a lot of questions before buying the stock.

Then, list the reasons why you think the stock price could rise and also the reasons why it could fall.

Then, if you believe that the stock is really worth investing into, move 5-10% of your financial savings into it. If the stock grows beyond 10% of your total financial investments, trim back to 10%.

If the stock falls, go back to your list. If the reasons you bought the stock still hold, buy more to bring your position back up to 5-10%.

If not, ditch the stock like your last office party’s leftovers.

Your boss will never know.