Thursday, December 22, 2005

Employee Stock Purchase Plan

Want a risk free (almost) investment that has (in my case) an annualized return over 100%? No, I'm not talking about Scamway or some other MLM waste of money. I'm talking about Employee Stock Purchase Programs. In general, these employer sponsored plans allow you to purchase your employer's stock at a discount. My company's program has the following features:


  • purchase periods every 3 month
  • can purchase up to 15% of your gross salary through payroll deductions
  • price is based on the closing stock price at the end for the 3 month period minus 15%
  • shares get deposited in a brokerage account 2-4 business days after the 3 month period
  • can sell stock as soon as it's in your account
  • fess are approximately $20 per selling transaction

So your are thinking to yourself: how does a 15% discount turn into over a 100% return? Buy as much as you can and sell as soon as you can. Let's look at an example (I'll be using trivial numbers for easy math):

  • annual salary = 40,000
  • quarterly purchase periods
  • 15% discount
  • stock price at end of period = 100
  • $20 commission

Step 1 - Calculate your gross return for one period

quarterly salary X 15% purchase limit X ((1/(1-15% discount))-1)

10,000 X 0.15 X 0.17647= $ 264.71

note: that weird transformation we did at the end of the calculation was to convert the discount to a rate of return

Step 2 - Deduct trading expenses to get net quarterly return

$264.71 - 20 = $244.71 net return

Step 3 - Calculate Annualized Return

(quarterly net return X number of purchase periods per year) / average invested dollars

($244.71 X 4) / ??

Step 3a - Calculate Invested Dollars

This is key... you can't simply look at the total investment because most of these programs are funded through regular payroll deductions. Therefore, at the beginning of each period you don't have any money invested and, in this example, you have the full 15% of your quarterly salary invested at the end of the purchase period. Your average invested dollars is really one half of the 15%. So, to calculate our average invested dollars...

(quarterly salary X 15% ) / 2

10,000 X 15% / 2 = 750

Step 3b - Plug & Chug

$244.71 X 4 / 750 = 130.1% annualized return

With the magic of algebra we can create a formula for the TERESPR (The Early Riser Employee Stock Purchase Return)...

d=stock discount

p=number of annual periods

s=annual salary

c=commission

x=percent of your salary you will be contributing

TERESPR= 2p/(1-d) - 2p - 2cp^2/sx

If we plug our prior example...

2*4/.85 - 2*4 - 2*20*4^2/(40000*.15)

8/.85 - 8 - 640/6000

9.41176 - 8 - .106667

1.30501 or 130.5%

A few words of caution:

  • Each ESP plan is structured differently so read yours carefully
  • The key to this being almost risk free is your ability to sell the stock immediately - if your plan restricts your selling, you have much more downside risk and this may not be for you
  • The profit is taxed like regular income... make sure you save some of your profits to pay the tax man
  • THIS IS NOT INVESTMENT ADVICE!!!

UPDATE: Political Calculations has built an on-line calculator!

21 Comments:

At 8:57 PM, Anonymous RS said...

My company used to have a pretty good ESPP program, but they recently changed it. It used to be a 15% discount, now it is just a 5% discount. Now I am not quite sure if it is worth it to be in anymore. I also cannot immediately sell the stock (unless I want to get kicked out of the plan for the remaining part of the period).

I am never sure anymore if it is worth it to invest in my ESPP.

 
At 12:53 PM, Blogger Early Riser said...

That stinks... I don't think I would be interested in the program that your company offers.. too much risk.

 
At 5:39 PM, Anonymous Anonymous said...

My company discounts the stock at 15%. The price is set at the beginning of the month and you buy at the end of the month. You have to hold it for a year before selling and paying $10 for the trade and 10 cents per share (Stock is around $75). This year I made 21% on my investement, but I am still not sure what percentage to invest between 0% - 10% (max)? I believe the year holding period and the need to hold onto shares and bulk sell to diminish the effect of the $10 trade will increase the risk of the offer, and the longer I hold onto the stock the less advantages the 15% discount becomes. Any thoughts?

 
At 1:37 PM, Anonymous dan said...

My wife just got a new job with a similar plan except she can buy up to $10,000 of stock per year, her income is the same. I want to supplement her income so she can invest the full amount but I am worried about a few key elements. Have you noticed any employee sell offs effecting the stock price? Similarly, have you noticed any trends on the last day of the quarter when the stock is priced?

 
At 5:06 PM, Anonymous Anonymous said...

Annualized return is a very deceptive measure in this case, because most ESPPs will have a cap on the total amount of stock you can purchase during a given year. 130% would only be attainable annually if you could forego this cap and continuously "flip" stock to reap the returns. Please blog responsibly, people take this stuff seriously sometimes.

 
At 6:15 PM, Blogger Early Riser said...

This last anonymous comment comes from someone at The Principle Financial Group... hard to believe a quality organization like The Principle would employ someone this dense. Either this chap is woefully misinformed or he's just being a jerk-store.

ROI is simply the return you can receive on a given investment. This investment happens to be limited based on company policy.

At my company, I am allowed to buy stock up to the lesser of $25k or 15% of my annual salary. I wish I wasn't limited but I am. The fact still remains, I'm able to attain an annualized ROI of $130+ % with very little risk.

 
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At 9:24 AM, Blogger ChrisMiller said...

Loved your algebra to do calculations. Can you share how the formulas would change to account for a rise in the stock price. I'm not a mathematician but I couldn't find in your list of variables the (stock price per share). Would think )stock price per share) could affect the formula and outcome greatly.

Thanks!

-C

 
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At 7:15 AM, Anonymous guelph payroll providers said...

It is indeed a very nice post. One can never image a company without a human resource management system. I would like to say that the biggest motivator for employees is the salary. But estimating how much payment an employee deserve is not an easy task.

 

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