Case Study: Daktronics - Brookings, South Dakota
This blog post is one of a series of blog posts we intend to publish in the coming months. In each post we will review various publicly traded companies, both locally and nationally. This is not intended to be commentary on any particular company - rather it is to illustrate the risks of owning too much in any one company stock. Publicly traded companies are referenced because the filings are readily accessible to the general public.
Company Stock in 401(k) Plans
Employers have offered employees the opportunity to invest in company stock within their 401(k) plan for years.
However, after the collapse of Enron and Lehman Brothers it seems to be a less prevalent option. In both those situations when the companies went bankrupt, employees lost their jobs and a significant portion of their net worth because many workers chose the opportunity to invest heavily in their company stock.
Diversify, Diversify, Diversify
Basic diversification rules suggest not having more than 5-10% of your investable assets in one stock. In terms of your employer's stock I would suggest not having more than 5% of your assets invested in it.
The reasons are simple. Your employer controls your income. If your salary is reduced or you are laid off, chances are your company is going through a difficult time. If the company is hurting, the stock likely is falling in value as well. In smaller communities, if they are a large employer and there are layoffs, the housing market can suffer as well, affecting the value of your real estate holdings.
Companies Make It Easy to Acquire Too Much Stock
Let's take a look at options a Daktronics employee would have to purchase stock in their company.
Daktronics offers a stock option plan to employees.
Stock option plans give employees the right to buy a specific number of company shares at a fixed price within a certain period of time. The fixed price is called the grant or exercise price. Employees hope to profit by exercising their options to buy shares at the exercise price when the shares are trading at a price that is higher than the exercise price.
EMPLOYEE STOCK PURCHASE PLAN (ESPP)
Daktronics offers an Employee Stock Purchase Plan to employees.
The ESPP allows employees to purchase shares of Daktronics common stock, subject to annual limitations, at a price equal to 85 percent of the lower of the fair market value of Daktronics stock at the beginning or end of each six-month offering period. So through payroll deduction there is an opportunity to buy stock at a discount.
Daktronics offers a 401(k) plan to employees.
One of the most utilized investment options within the plan is Daktronics stock.
Finally, anyone can purchase shares of Daktronics stock on their own. So, an employee in theory could hold stock options, purchase through the ESPP, purchase via the 401(k), and then buy their own.
How Has Daktronics Stock Performed?
Annualized Return: DAKT
Annualized Return: US Stocks
Through April 9, 2020. Market Index: Morningstar US Market TR
As we can see, the stock has performed quite poorly over the years. The negative returns affect shareholder employees in numerous ways. The most obvious is the loss of money on their investment.
During difficult business cycles such as the one we are in the pain increases.
With the unprecedented impacts of COVID-19, Daktronics recently was forced to cut pay and suspend its dividend indefinitely. Until recently shareholders had been receiving a dividend yield in excess of 4%.
If you own a bunch of company stock you've just lost a lot of income. Your salary may have been reduced. And an investment that was paying you over 4% per year in dividends just took away a major part of its shareholder return.
How Much Daktronics Stock Do Employees Own in their 401(k) Plan?
This data is as of April 30, 2019 and only represents the stock owned in the 401(k) plan (Not the Employee Stock Plan or Stock Options):
Daktronics employees owned 2,652,386 shares of Daktronics stock in their 401(k) plan.
This is equal to 5.2% of all Daktronics shares outstanding. That means the 401(k) plan is a significant holder of the market value of Daktronics.
The value of that stock was $20,107,503.
Total assets in the 401(k) plan were $150,733,130.
That means that over 13% of the assets in the Daktronics 401(k) plan were held in Daktronics stock alone.
What Is the Overall Asset Allocation in the Daktronics 401(k) Plan?
One way to offset the risk of excess employer stock holdings would be invest the rest of the assets more conservatively. Unfortunately for plan participants that is not the case.
Target-date funds have been a popular choice in most 401(k) plans in the last decade. They offer easy diversification for plan participants without a lot of investment experience. They offer a balance of stocks and bonds and get more conservative the closer you get to retirement.
In the Daktronics plan only 16% of the assets are in these balanced funds. If we take away these assets, we get a real picture of how 401(k) participants are allocating their funds.
Close to 90% of the participant balances are in equity/growth type investments. Only 10% of the assets are held in fixed income/stable type investments.
At a time when most investors need stability, many participants have put the majority of their assets into stock investments and company stock.
Where Should I Own Employer Stock?
In the case of Daktronics or any company with an Employee Stock Purchase Plan, it would make sense to accumulate shares via the ESPP program. This gives you the opportunity to buy the stock with a buffer, in this case a 15% market discount.
I would strongly recommend against using your 401(k) deferrals to purchase stock. 401(k)s are a large component of your long-term savings and should be as diversified as possible.
What If I Already Own Too Much Employer Stock?
Create an exit strategy
Look at how much you currently own. Decide what an ideal amount to own would be. Determine what timeframe you would like to reach your target allocation. Then sell some each month until you reach that goal.
For example: Let's say you own $500,000 of company stock when you should own $50,000. You need to unload $450,000 of company stock. It wouldn't be prudent to do all at once as we have no idea where the stock price will go in the short-term. If you decide you would like to be in balance in one year, you should sell $37,500 monthly ($450,000 / 12 months) and reinvest it into a more diversified portfolio.
Choose where to sell first
The easiest place to make these sales would be in your 401(k) to avoid any adverse tax consequences.
However, if you have worry about your employment or your current financials then it makes sense to look at selling the non-retirement holdings to create liquidity.
Reallocate your future contributions
The other part is to not increase your exposure. Stop all future 401(k) contributions from going into company stock. New money should be allocated to a diversified investment portfolio. If you own stock outside of the 401(k) make sure to stop reinvesting any dividends. A lot of plans have the dividend automatically reinvested into the stock which increases your exposure over time.
Do You Have Questions? Schedule a Free Consultation With Birch Investments.
Information is from sources deemed reliable. Blog is intended to be general commentary not specific advice. Please review our disclosures.
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