Anes Weblog » Employee Stock Purchase Plan ( ESPP )

Employee Stock Purchase Plan ( ESPP )

09 06 05

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Many companies have them, yet not every employee takes advantage of them. I wonder why?, and the only reasons I can come up is: lack of knowledge, laziness, or the fact that most people live paycheck-to-paycheck -- All of them are conditions that can be fixed if we really want to.

I think Employee Stock Purchase Plans deserve some more attention by all of us.

This is the deal on how they work:
For six months you contribute certain percentage of your salary and compensation (up to a maximum). At the end of the six months that money is used to purchase company stock. The price at which you buy is usually discounted at 85% of the LESSER between the price at the beginning of the period and the one at the end.

You can sell it the next day after the ESPP period concludes, and you will most probably get around 100% of the value of the stock at the end of the period. You will incurr in a gain for doing nothing more than electing an automatic contribution to the plan. Granted, stock prices fluctuate, but most days they don't fluctuate by more than 5% up or down.

Chances are you will win 17.6% in 6 months (17.6% = 15/85, and 6 months is a common ESPP period). That is the equivalent of an anualized 35.2%. Not too many investment opportunities give you that kind of return. There is no bank account that offers it. And most stocks can't support that kind of growth (if you can consistently pick them like that, we have to talk). It is one of the best investments you can get, and many people don't make use of it.

Let me illustrate the example better:
Situation 1: (bad company)
Begining of period price:    $20.00
End of period price:                $10.00 (50% drop)
Day after ESPP period price:   $10.00
Purchase price:                $ 8.50
Gain:                            $ 1.50 (or 17.6% of anything you put)

Situation 2: (great company)
Begining of period price:    $10.00
End of period price:           $12.00 (20% gain)
Day after ESPP period price:    $12.00
Purchase price:             $ 8.50
Gain:                         $ 3.50 (or 41.2% of anything you put)

Situation 3: (terrible company)
Begining of period price: $20.00
End of period price:        $10.00 (50% drop)
Day after ESPP period price: $ 9.50 (Another 5% drop)
Purchase price:                    $ 8.50
Gain:                                $ 1.00 (or 11.8% of anything you put)

I do see only one tangible drawback to these plans. You have to put aside (the company does it) money out of your paycheck. This means less money on the paycheck. Less money on the paycheck can be good: It is an opportunity to automatically save and invest in a big way.

I understand not everybody can afford to start using ESPP plans with the maximum allowable amount. But if you are already maximizing your IRAs and 401k plans, I do suggest you try them. Contributing another 2% will not hurt you. You will get used to it, and you will get even more used to seing your portfolio grow.

Words of caution:

You have to find out when the open enrollment date is. You can only enroll on some periods of time.
You have to find out what the plan end date is (and beginning of next one).
Under most circumstances, you want to sell the stock AS SOON AS THE PLAN PERIOD ENDS!
Why? To minimize risk.
Q. Have I considered accumulating the stock I buy through ESPP?
A. Yes, I have considered it. It does offers tax advantages if the stock gains and you hold it up for more than a year. But I want to present a relatively safe way of making money (if your company has such a plan). As to whenether you keep the stock or not, ask yourself the following questions: if I had an extra amount of money, and I didn't worked for this company, would I buy the stock? If I keep the shares, would my stock portfolio be balanced? (not all eggs in one basket) If the answer is yes to both, then by all means keep the stock. Usually, the answer is no to at least one of them.

Further Information:

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I think everyone should take advantage of the ESPP program. Like you point out, it is an almost guaranteed 17% ROI and the potential to make even fatter profits during some periods. I would play those odds anytime. One big caution though: Almost everyone should sell as soon as they get the shares in their account. Investing your money in your employer should always be approached with extreme caution. Chances are if the stock tanks, the job is in jeopardy as well.
I say this because I once worked for a small tech company. Lot of co-workers participated in ESPP at mid-twenties. They didn’t want to sell immediately and make a measly 17%. Stock tanked below $5 and the company was bought out at single digits and many were laid off. Some people were out of a job, lost a bundle in the stock and had to pay tax on the “ESPP benefit”. Ouch!
Arbee () (URL) - 09 06 05 - 15:16

I used to participate in my company’s ESPP, but recent accounting rule changes caused them to lower the discount from %15 to %5. Needless to say, I opted out as the reward didn’t balance out with the risk.
blogreader - 09 06 05 - 21:44

The down side of participating in ESPPs is that they are just about the opposite of diversification. You already — most likely — depend on your employer for your salary and health insurance, and they’re probably your primary retirement savings vehicle as well. And they’re your absolute biggest time investment.

If something happens, don’t be screwed on all fronts. Think about all the people who put $$$ into Enron’s ESPP and corporate stock in their 401ks.

IMO, it’s better to max out retirement contributions in low-fee mutual funds, get your 3-6 month $ cushion in place, and even save for the other things in life you want to save for (house, kids, even vacation) before investing any “leftover” money into your own company stock.

That said, I put 1% into my previous employer’s. But I’m hoping to leave it alone for another year to avoid capital gains taxes. Including my discounted price (15%) I’m up almost 25%, but that winds up being on the order of $300. Fortunately, I did most of my purchasing when it was tanking a couple of years ago. I feel bad for the many people who bought during the bubble.
LesbianMoney () - 14 06 05 - 16:47

Question? Are you also factoring in that you must pay income tax on the 15% discount as well as taxes on the capital gains in the above examples?
dandag () - 24 06 05 - 13:58

dandag: Taxes are not factored in on the calculations. You need to put your own numbers there.

If you sell the next day (as suggested on the article), you will most probably worry about INCOME tax only, since the price will be very close. Small capital gain or losses may still have to be accounted, but it would be minimal, unless you decide to hold for a longer period.

Yes, you will pay taxes over the extra income suggested. The rate at which you are taxed depends on your income level. Your company will take care of the accounting and report it on the W-2. But you will still receive money in your pocket.
Jose Anes () (URL) - 26 06 05 - 02:55

Jose Anes: I enrolled in my employer’s ESPP program: http://canadiancapitalist.blogspot.com/2005/06/enrolling-in-espp.html.
Not to nitpick, but the annualized return is more like 70%. That’s because funds are withheld over time and the average holding time is 3 months.
Arbee () (URL) - 26 06 05 - 23:19

Hi! How to me to adjust a background of page?
Jonn () (URL) - 24 12 05 - 01:20

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Employee Stock Purchase Plan ( ESPP )

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