What is an Employee Stock Purchase Plan (ESPP) and Should You Invest through One?
If you work for a public company, you may have a worthwhile benefit called an Employee Stock Purchase Plan (ESPP). These plans are offered to all employees just like healthcare or holiday pay is applied across the board, and it might be a very smart move to funnel some money into one. An ESPP allows employees to purchase the company’s public stock through payroll deductions (after taxes) and usually at a discount to the market price. The discount varies, but usually caps out at 15%. So here’s the main question: should you invest your hard-earned paycheck into your company’s stock?
You can answer that question by asking yourself the following:
- Do I know where the company is going? Do you understand the financial outlook of the company? Is it a mature company that is not likely to see a lot of growth? Is it a growing company that is expanding rapidly but still showing losses? Do you really understand the business? Because the last thing you want is for this thing to implode Enron-style.
- Do I believe the company’s stock is fairly priced? You may work for a great company, but what if you work for a really great company, the Googles and the Apples whose stock are closely followed, traded at high volumes, and perhaps overvalued due to all of the speculation and enthusiasm? Sometimes too much enthusiasm can backfire. On the other hand, before Marissa Meyer joined Yahoo! and the stock price climbed about 70%, Yahoo! shares were significantly undervalued, at one point trading for less per share than what the value of all of Y!’s cash assets were (including its Alibaba stake). But Yahoo! wasn’t sexy then, which is exactly when an employee purchasing stock at a discount to market could have been making a very good investment.
- Would I purchase stock on my own without the ESPP? Would you? Would you take the time to buy shares on your own, without the discount? Remember, just because it’s on sale doesn’t mean you have to buy it.
- Have you calculated the cost and benefit? For example, let’s say your company’s shares trade at $10/share. You set aside $1000 from your paycheck to purchase shares. On the open market, you would have received 100 shares, but thanks to your $8.50 share price, you can purchase 117 shares and have a few bucks left over to buy a Coffee Bean Ice Blended Hazelnut drink (or a margarita at happy hour). Or you can decided to just buy those original 100 shares for $850 instead of $1000. When it comes time to sell those shares, here’s an easy reference on how the proceeds get taxed.
ESPPs are a great way to start investing, especially if you understand your company and its prospects for growth. If you work for a blue chip company, the ESPP may simply be a nice way to invest in a solid stock at a discount to the market. There are usually not that many rules attached to when you can sell these shares since you are paying for them with your own payroll deductions, so maybe there are even some short-term opportunities to make money (but your company may not encourage that!).
Have you ever invested through an ESPP? Did you get really, really rich? Tell me about it!