Background
We most recently valued shares of Eli Lilly (LLY) for clients in April this year. The thrust of our opinion at that time was focused on whether the Trulicity franchise was appropriately recognized by the stock price. We didn’t comment on long-standing rumors that the company would spin off its Elanco Animal Health unit. However, the company announced plans to do exactly that on July 24. That announcement, plus solid 2Q18 results, have driven the stock significantly higher over the last two weeks. The stock set its previous all-time high ($93.06) on December 29, 2000. July 24 saw a new high, and the stock has trended higher since. As of this blog, LLY shares are trading at $102.93 per share.
17 and a half years is a long time to wait for a new high. So the buzz among employees and retirees whether to reduce exposure to LLY is understandable. To be clear: we don’t own the stock in our managed portfolios, so we only value the shares on an as-needed basis for clients who hold them independently. Consequently, this is not a recommendation to sell Lilly shares. Nor is it a formal opinion about valuation. Rather, we thought it would help to review ways to reduce exposure for people who have already made the decision to do so.
Quantifying Your Exposure
If you’re a current employee of Eli Lilly, your paycheck is likely your single largest exposure to the company. You may also have exposure through LLY shares in your 401(k) or directly as the result of incentive compensation. Examples of incentive compensation include Restricted Stock Units, Performance Units, and options. Each of these should be considered when evaluating whether and how much to sell.
Tax-deferred and Tax-free Alternatives
If you decide that you want to reduce your exposure to LLY, the first place to start is by not buying more. If you are buying shares in your 401(k), consider routing new contributions to other investment choices.
Next, if you own shares in your 401(k) – from your prior purchases or company matches – you can sell shares and reinvest in other fund choices. This also effectively rebalances your account. There was a rumor circulating for years that you couldn’t sell your LLY shares in your 401(k) until you reach retirement age. Like other public companies, Lilly periodically restricts liquidations around earnings announcements (“blackout periods”). But beyond that, you don’t have to hold your vested shares for a set time. The main benefit of selling within your 401(k) is that it is not a taxable transaction.
Charitable gifting is another possibility for lessening exposure. Many non-profit organizations have brokerage accounts to receive gifts of stock. When donors give stock from an after-tax account, they are not liable to pay tax when the charity sells the shares. And the charity – as a non-taxable entity – pays no capital gains tax on the shares when sold. For long-time Lilly shareholders, capital gains can be significant. Giving appreciated stock is a way to avoid the substantial capital gains that would have been realized if the donor sold the shares himself.
Gifts of stock may be deductible, too, though changes in the tax law last year make checking with your tax advisor even more important. An important side note: it may be worth your while to gift more than one year’s worth of charitable pledges in this tax year, as we wrote about in May. Keep in mind that to deduct the full market value of the stock gift, unrealized gains must be long-term (see below).
Taxable Sales
If you’re contemplating selling shares that you own outside your 401(k), keep the following principles in mind:
- Sell shares that you’ve owned for longer than 365 days. One year is the demarcation between short-term and long-term capital gains. Short-term capital gains are subject to the rate of your ordinary income tax bracket. Long-term gains are taxed much more favorably.
- Sell long-term shares with the lowest percentage gain. For example, let’s say you acquired 100 shares through Restricted Stock Units at the ends of January 2015, 2016, and 2017. The January month-end closing prices for LLY on those dates were $72.00, $79.10, and $77.03, respectively. The lot to sell first is the one acquired in 2016, because your cost basis is highest, thus your gain will be lowest. After that, you should sell the 2017 lot, and finally the 2015 lot.
Conclusion
How much exposure to Lilly (or any other single company/employer) is too much? We don’t recommend arbitrary levels of employer stock exposure. Rather, we prefer to understand and convey the risk for each client who holds the stock, individually. We do this in light of their unique time horizon, liquidity needs, financial, and emotional risk tolerance. While we’re not recommending selling the shares, there are strategic ways to reduce exposure once that decision is made. We certainly appreciate why the conversation is a hot topic with employees today.
Disclosures
Peloton Wealth Strategists owns the common stock of Eli Lilly & Co. for certain clients at their discretion. The opinions expressed above should be construed as neither investment advice nor a solicitation to buy or sell securities. Peloton Wealth Strategists assumes no liability for losses pursuant to investment actions entered into as a result of opinions expressed herein. Changes in economic and capital market conditions and the unique objectives of each investor should be considered before investing in securities.
Sources: Bloomberg, YCharts