My employer offers a Employee Stock Purchase Plan (ESPP) that is typical of the kind offered by many tech companies. The plan allows employees to contribute a certain percentage of pay and allows them to buy company stock twice a year at a discount.
The way I see it, if the discount is large enough, such ESPP plans are an excellent opportunity to earn extra returns with very little risk. To illustrate how you can almost always profit from such plans, let’s consider two scenarios for the ESPP plan offered by ABC Widgets Inc. (ABCW). The ESPP plan has two offering periods per year (March 1st to August 31st and September 1st to February 28th) and employees can contribute a minimum of 2% and a maximum of 15% of their total pay. Company stock is purchased under the plan on the last day of the offering period at a 10% discount to the lower of the closing price on the start date and the closing price on the end date of the offering period.
Scenario 1
ABCW closed at $10 on March 1st and at $12 on August 31st. Under the ESPP plan, shares were purchased for you at $9 (minimum of $10 and $12) and you sold the stock at $12 on September 1st. Profit = 33%.
Scenario 2
ABCW closed at $12 on September 1st and closed at $10 on February 28th. If you sold the stock at $10 on March 1st, your profit will be 11%.
As it is risky to hold your company stock, the best option is to sell immediately and bank the profits. Still, there is a small risk in participating in these plans - the stock could open significantly lower on the next trading day, wiping out your profits and then some.
Under criticism from shareholders, many attractive features of ESPPs are being cut back or eliminated, while rich stock option grants are still being made to top executives. ESPP plans with a “look back” feature (a low stock price is locked in) of as much as two years are now very rare. Even discounts (15% used to be common) are less generous these days and may be as low as 5%. If the discount from market value of your ESPP plan is 5% or less, the profits under Scenario 2 is only a little more than a high-interest savings account.
In Part II, we’ll look at another flavour of ESPPs, in which you contribute a smaller portion (2% to 5%) of your salary, which is matched in part or full and company stock is purchased at no discount in every pay period. In Part III, we’ll look at tax considerations of ESPPs.
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6 responses so far ↓
1 Aleks // Aug 20, 2007 at 5:50 pm
I just sold out of IBM’s ESPP. The discount is only 5%, there’s no look-back or other discounts (you buy shares at the current price each pay period), and once you sell any shares you’re locked out of buying more shares for a year. That, plus having my investment and employment eggs in the same basket and my suspicion that the US bull market is over made me decide that the ESPP is not, in fact, free money.
2 Canadian Capitalist // Aug 20, 2007 at 7:01 pm
Aleks: I believe IBM was among to first to cut back on the discount and eliminate the look back. My employer’s discount is 15%. If it is only 5%, I may not participate.
3 Tom // Aug 20, 2007 at 9:05 pm
FYI, this is a US style ESPP, as defined by section 423 of the US internal revenue code. You’ll likely see this kind of plan set up if you work for an american company.
Canadian companies more typically have the second flavor of ESPP which you mention, in which the discounted price and is replaced with the company match portion.
4 Dan // Aug 21, 2007 at 7:07 pm
ESPP plans vary dramatically in the amount of discount and the length of time the individual gets to keep their discount. About 50% of companies have 6 month purchase periods (”contribution periods”) as described in the original posting. The 10% discount does nto seem like much, but consider that it is difficult to get a 10% return on any investment over a six-month period.
If you are very conservative you can sell immediately after purchase an take the approximately 10% (minus ay taxes). If you are more confident in the company;s stock you can hold on and make more. If you happen to end up being a US taxpayer, you can even get a discount on taxes if you hold the shares long enough. If the stock rises during the purchase period your gain is certain to be more than 10% if you sell immediately.
These plans are excellent way to become a stock owner. They are also a great way to “buy your bonus”. Many companis pay bonuses of less than 10%. If you can afford to contribute the max, and you sell right away you can augment your corporate bonus nicely.
Be aware of other discounted or match style programs your company offers and seek professional help in comparing them. You may find that putting away everything possible today, is a great way to put away less tomorrow.
5 Warren // Aug 29, 2007 at 4:46 pm
My employer (very large US company), offers up to 15% of my salary deducted for a quarterly purchase at 15% off the value at either the beginning or the end of the period. It used to be 15% off the lowest value throughout the offering period, which was awesome.
As mentioned above, good luck making this kind of return over 3 months with almost any other investment.
I used to flip it every 3 months, but in the last few offerings I’ve decided to hold on. Its a blue chip stock, so there won’t be any major swings, but I’ve been reading some favorable analysis and I think it has a chance to grow, plus the odd dividend doesn’t hurt.
6 Profit from Employee Stock Purchase Plans (ESPP) - II // Sep 16, 2007 at 8:00 pm
[...] are used to purchase company stock at market value once during every pay period. This flavour of ESPPs differ from those offered by US-based companies in two [...]
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