Feb

20

ESPP: Employee Stock Purchase Plan

February 20, 2008 |

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 annualized 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)

Beginning 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)

Beginning 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)

Beginning 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 seeing 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 when ether 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.

Q. What Is the Tax Effect?

A. Your company will calculate the discount as income, and will charge your regular tax rates on them. If you sell at a gain from the fair market value of the stock at the day of the grant (the day you get the stock at the end of the period) you will probably pay short (or long, if you hold for log) capital gain taxes. You may also experience a loss from the fair market value to the time you sell. I strongly recommend you sell at the first possible chance.

Q. ESSP, isn’t that double expossure?

A. If you hold your stock for long, yes, it is double exposure. If you sell your stock the next day after they grant it to you, you limit your exposure considerably. Remember that you can always cancel your ESPP subscription in the middle of the period and get your money back. What you can not do is join in the middle of a period.

Further Information:

Bloggers with ESSPs:


Comments

1 Comment so far

  1. your employee stock purchase plan espp own company at discounted on June 21, 2008 3:10 pm

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