My US employer offers stocks for employees with a certain discount up to a max limit per year. What are the advantages and disadvantages of buying these stocks?
The employer is Microsoft
Personal Finance & Money Stack Exchange is a question and answer site for people who want to be financially literate. It only takes a minute to sign up.Sign up to join this community
The typical deal is you can put 10% of your gross pay into the ESPP. The purchase will occur on the last deposit date, usually a 6 month period, at a 15% discount to the market price.
So, the math is something like this: Your return if sold the day it's purchased is not 15%, it's 100/85 or 17.6%. Minor nitpick on my part, I suppose. Also the return is not a 6 month return, as the weekly or bi-weekly deductions are the average between the oldest (6 mo) and the most recent (uh, zero time, maybe a week.) This is closer to 3 months. The annualized rate is actually pretty meaningless since you don't have 4 opportunities to achieve this return, it's important only if the cash flow hit causes you to borrow to support the ESPP purchases.
The risk is whether the stock drops the 15% before you can execute the sell to take advantage of the gain.
Of course the return is gross, you need to net for taxes.
Edit to respond to comment below - When I said meaningless, I meant that you can't take the 17.6%, annualize it to 91.2% per year and think your $1000 will compound to $1912. It's as meaningless as when an investor gets a 10% gain on a stock in one day, and (with 250 trading days per year) decides his $1000 will be worth $2 quadrillion dollars after a year. The 17.6% is significant in that it's available twice per year, for a true 38% return over a year, but if borrowing to help the cash flow, that rate is really over 3 months.
It would be difficult to answer without knowing specifics about a particular offer.
In certain cases, it's definitely great and one could become a millionaire [Google for example]. In other cases one could lose money. In most cases one makes a decent return.
As the specifics are not available, in general look out for:
Most of these would determine if the plan is good for you to get into.
Advantage: more money. The financial tradeoff is usually to your benefit:
Given these, for having your money locked up for the average length of the vesting periods (some is locked up for 3 months, some is locked up for nearly 0), you get a 10% return. Overall, it's like a 1.5% bonus for the year, assuming you were to sell everything right away.
Of course, whether or not you wish to keep the stock depends on how you value MSFT as an investment.
The disadvantage lies in a couple parts:
You should always always enroll in an espp if there is no lockup period and you can finance the contributions at a non-onerous rate. You should also always always sell it right away regardless of your feelings for the company. If you feel you must hold company stock to be a good employee buy some in your 401k which has additional advantages for company stock. (Gains treated as gains and not income on distribution.)
If you can't contribute at first, do as much as you can and use your results from the previous offering period to finance a greater contribution the next period. I slowly went from 4% to 10% over 6 offering periods at my plan.
The actual apr on a 15% discount plan is ~90% if you are able to sell right when the shares are priced. (Usually not the case, but the risk is small, there usually is a day or two administrative lockup (getting the shares into your account)) even for ESPP's that have no official lockup period.
see here for details on the calculation.
Just a note For your reference I worked for Motorola for 10 years. A stock that fell pretty dramatically over those 10 years and I always made money on the ESPP and more than once doubled my money.
One additional note....Be aware of tax treatment on espp. Specifically be aware that plans generally withhold income tax on gains over the purchase price automatically. I didn't realize this for a couple of years and double taxed myself on those gains. Fortunately I found out my error in time to refile and get the money back, but it was a headache.