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.
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%.
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 (available here), 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 (available here), we’ll look at tax considerations of ESPPs.