I have long railed against the buying and selling of individual stocks. Here are some examples just from the blog. The ones I didn't write in 2019 were republished in 2019 as part of our Tuesday Classics Series.
- Uncompensated Risk
- Picking Individual Stocks is a Loser's Game
- Why Talking About Individual Stocks (and Sectors) Makes You Look Dumb
Individual stocks add an unnecessary risk to a portfolio, an uncompensated risk called individual company or individual security risk which can easily be diversified away. Since it can be diversified away, there is no reason an investor should earn a premium for taking it. The publicly traded stock market may not be perfectly efficient, but it is efficient enough that acting as if it were perfectly efficient is generally the right move, even for a fairly experienced and sophisticated investor.
So how is it that I came to own an individual stock? I didn't buy an individual stock, nor was I gifted one. One of the private real estate companies I owned went public.
Broadmark Private Company
Long term readers may recall that my portfolio is 60% stocks, 20% bonds, and 20% real estate. Of that real estate portion, 5% is publicly-traded REITs, 10% is private equity real estate (funds and syndications) and 5% is private debt real estate, primarily funds. One of those funds, and in fact my favorite private real estate fund, was Broadmark Fund III. This fund made loans to developers and house flippers in Utah and Colorado. It paid me 10-11% like clockwork and simply reinvested the money every time it was paid. My only regret with the fund was that I bought it in a taxable account (this asset class is terribly tax-inefficient).
I put $75,000 into it on 11/6/2017. By the end of 2018, it was worth $83,404.31, a 2018 return of 10.28%, at least pre-tax. By mid 2019, I was ready to double or even triple my investment. Then the changes began.
First, it became a REIT instead of a private fund. This was presumably in response to the 2018 TCJA. REITs were now eligible for the 20% 199A deduction, so instead of paying taxes at my ordinary income tax rates on the entire return of this fund each year, I would only pay tax on 80% of the total return. That's a good thing for me.
However, a couple of months later they started talking about it going public. They started sending lots of paperwork about how this was going to be great for investors and great for managers and even great for the business. I wasn't entirely convinced, so when it came time to vote my shares, I actually voted “no.” The main reason was that I was perfectly content with the way this REIT was performing. Stock returns but no apparent correlation with the stock market. It seemed to be well-run and admired by its peers. What's not to like?
For better or for worse, I was outvoted, and the stock went public on 11/15/2019, almost exactly 2 years after I bought into the company. The value of my investment at the time was $93,698.75. In exchange I was given 8,964 shares. That works out to a price of $10.45 per share.
To be fair, there was plenty of notice about this. I could have sold before it went public. I could even have bought more. I chose not to buy more because it simply felt too speculative to me. It felt like I was buying an individual stock for the short term. But at the same time, I suppose NOT selling the shares before it went public was also a speculative move. Every investor had to decide how they felt about this. Another experienced long-term investor (that also voted “no”) I know chose a different route than I did, he sold half his shares and held on to the rest.
One nice thing about voting “no” was that because the company was based in Washington, we could take advantage of a Washington State law that allowed us to “put” the shares back to the company at our basis until December 20th. When I saw that, I figured, “Hey, no reason to sell before then, let's see what happens in the first month.”
Broadmark Stock
By the end of the day on November 15th, Broadmark shares were trading at $10.95 a share. By the end of the month, they were trading at $11.16 a share. I was getting rich! Of course, I was mad I hadn't bought more, but I was also glad that I had not sold before it went public.
In the meantime, I started looking into how to sell my shares. They were being held by a “stock transfer company.” I logged into my account there and it didn't look anything like my Vanguard, Fidelity, or Schwab brokerage accounts, so I called them up. They confirmed for me that they could sell my shares for me, but that the commission would be close to $800-900. They also noted that they don't necessarily get the best price since they aren't really a brokerage.
I asked how I could transfer the shares over to my Vanguard brokerage account and they told me how to do that and that it wouldn't actually cost me a thing to do so. So I initiated that process. The only hiccup was that the brokerage account was in both of our names and this stock transfer account was only in mine. So I had to open another Vanguard brokerage account only in my name to transfer the stock into. Another phone call to Vanguard and within a week or two, the shares were there, waiting to be sold. The 20th came and went, and the stock kept going up (along with the overall market.)
To be fair, I had a pretty good idea this stock was going to go up significantly after the IPO. It was a good company and a good fund. Plus, its yield was way higher than those of its peers in the eShares Mortgage REIT ETF REM. But at the end of the day, it is an individual stock. Katie and I talked about whether we were comfortable holding an individual stock as part of our 5% debt real estate allocation, and we really weren't. So with a bit of reluctance, I put the sell order in on Christmas Eve from Costa Rica. I sold the shares at $12.5411 per share, leaving me $112,416.09. I earned 33.67% on it in 2019 for an annualized return over the two years I owned it of 20.91%, pre-tax. Not a bad little investment, especially since I was expecting 10-11% out of it.
Speaking of taxes, I was a little hesitant to sell so quickly and owe short term capital gains taxes on the sale (although most of my gains would be long-term since only the reinvested dividends for the last 10-11 distributions are actually still short term). Luckily, in December 2018 we did a bunch of tax-loss harvesting. We still had $70-80K in tax losses we could use up, so the actual sale won't cost us a thing in taxes. In fact, selling it for short-term capital gains was the most tax-efficient return I ever got out of it! Much smarter tax-wise than waiting until it paid its 12% dividend out in December!The money was moved back into the rest of my asset allocation (we were actually a little heavy on real estate debt, so it's going into real estate equity, REITs, and the overall market) and we move forward following our written investment plan. Overall, it was a fun experience to own something before it went public. Obviously we made out well (although by the time this runs in a few months we'll know if I missed a huge run-up after selling). I was surprised how much harder it was to sell a winner I knew I needed to sell when I owned it versus when someone else (like my parents) owned it. It is much harder to be logical and rational with your own money it turns out.
[Update just prior to publication: If you're interested in the rest of the story, the stock peaked at $12.73 on February 21st, dropped as low as $5.82 per share (54% drop) and is now trading at $9.65 per share (66% gain). Overall, I'm pretty happy with my timing!]
What do you think? Have you ever owned a company before an IPO? What was your experience like? Did you own Broadmark? What did you do with it- sell before the IPO, sell after, or hold on to it? Comment below!
Thanks for the post. In 1978, I received as a college graduation present 250 stock shares of what is now renamed Dominion Energy. Over the years I have contributed to the stock through their direct investment program and have reinvested every single quarterly dividend. I basically have just let it roll. It has never occurred to me to sell the stock as I am obviously “in” for the long haul. Not all individual stocks are bad deals. Just realize to not put all of your eggs in one basket and diversify with other investments.
No, they’re not all bad deals. But for everyone with a story like yours, there are several people who held Enron while it went to $0. Just because the risk doesn’t show up every time doesn’t mean it is sometimes smart to run it. It’s uncompensated risk.
Kudos to you on your discipline! Many people may not have been able to pull the trigger on “Sell” with it looking so good after its IPO- particularly when you judge the underlying investment to be sound. Happy your timing turned out so good. I’m guessing the drop off the cliff was thanks to COVID, rather than a fundamental shift in the investment itself.
Look out…Here is what’s up next for WCI 😉
https://twitter.com/stoolpresidente/status/1271535637204815876?lang=en
Stick with a buy and hold strategy and fund it adequately, and you too can have days where you gain or lose that much in a day, no day trading required.
On a side note…good move getting out when you did. Worked out nicely for you. Here is the way I might have played this depending on my belief in the company. Assuming I believed that they were a good company and that I believed that the company could outpace the S/P going forward (I know nothing about this company) I might have done one thing differently.
I probably would have gotten my basis out of the stock. In your case this would have meant selling off about 6,800 shares at $12.54 (this would roughly cover your basis and your taxes. If you take out the tax portion because of TLH then it would have been about 6,000 shares sold. I would have kept the remaining shares and played my “free ride”. Obviously right now you would be beating my hypothetical stock play by a significant margin. I offer this up only as a tool for learning as to how people might deal with a similar situation.
Thanks!
That’s just psychological trickery. The old “I’m just playing with house money” thing. The reality is that there is no house money. It’s all yours to lose. If it’s not right to hold half of it, it probably isn’t right to hold any of it.
I did about the same thing you did! I’d bought into it about a year and a half before it went public and loved the like-clockwork distributions. But after it went public I was pretty concentrated in this one stock so sold in Feb and made about a 30k profit, putting the proceeds back into cash and index funds; glad I did.
@NapoleanDynamite
IPOs are carefully planned, marketed and launched to benefit VCs, institutional funds, large early stage investors and founders in that order. The Broadmark deal is pretty typical with about a dozen insider shareholders. It’s relatively easy to make multiple XXX returns after personally stacking the deck and getting enough market float pre-sold to guarantee a one day pop. If that can’t be effectively guaranteed, the offering will either be postponed or cancelled.
https://www.cnbc.com/2019/04/03/dont-be-fooled-by-the-unicorn-hype-this-year-most-ipos-lose-money-for-investors-after-5-years.html
Everyone else comes along for the ride with a far higher cost basis followed by the public . If you’re fortunate enough to acquire pre-IPO stock at a discount and sell it profitably as an outsider after the lockup period ends, you’re doing quite well. One tech startup I worked at went public within five years. I sold it all for similar reasons as WCI because the Amazons of the business world are rarer than real-life unicorns.
Check out the pink sheets for a cheaper way of learning the same things. It’s speculation at its finest. 😉
Congratulations on your success with an individual stock going public! Here is my one tale of owning the stock of a company before it went public and it is very relevant to physicians. When I first started practicing in the mid 90’s, the practice which I joined purchased medical malpractice insurance from a private insurance carrier, MIIX. In the late 90’s I believe, the company went public and all the shareholders (ie the insured physician clients) were given stock in the company. I think I was given approximately 250 shares totaling maybe $3,000-4000. I basically didn’t pay much attention to it because it was a small sum of money and my group had paid the premium so I viewed it as free money. This was a silly, rookie mistake for sure. Here is what happened next.
After 9-11, the stock markets cratered and the stock was hit along with the rest of the market. Around that time, the CEO of the insurance company was arrested for growing pot in his house (another good sell signal which I didn’t pay attention to). Then the company went into financial distress and eventually went into bankruptcy with voluntary runoff and the stock was worthless. The stock becoming worthless was not my concern. It was a good lesson for me that I have to pay attention to everything in my investment portfolio because I had just wasted $3000 for no reason other than my ignorance.
Of more concern to me and those of many of the physicians in my state was that there would not be sufficient funds to cover malpractice claims and if not, would the insured physicians be personally liable in this situation. Fortunately, I never had a claim against me so I didn’t have to find out. One of my friends was pressured to settle a lawsuit by her attorneys and representatives of the insurance company. It was a very stressful situation. Here is a link:
https://www.programbusiness.com/news/NJ-Insurer-Miix-Group-Subsidiary-File-for-Chapter-11-Bankruptcy-in-Delaware
Wow, I did not get so lucky with those individual stock picks 🙂 I recently shared my story about that back in the 08-09 Great Recession. I’d just gotten into investing as a young tike and managed to commit the worst of sins at the bottom around Spring 09. Yup, no 66% gain for me! Worse still, I’d made the decision to buy stocks in the first place — no IPO came knocking! 🙂
Glad to see it’s worked out and you’re back in the well-allocated broad funds!
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The main reason was that I was perfectly content with the way this REIT was performing. Stock returns but no apparent correlation with the stock market.
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Could you go into a little detail on why the same underlying investment is correlated with stocks after it is listed and not before? Is it simply a matter of price discovery? Or is it due to being listed in the same market as stocks? Or is there something more?
I’m not sure I know exactly why, aside from the fact that the investment became better known and more liquid by going public.
thank you for giving the white coats a fair shake