Is an employee stock purchase plan a good deal?

My wife works for a Silicon Valley mega corp. Recently, her boss was talking up the incredible benefit of the company employee stock purchase plan. He couldn’t understand why people would pass up the chance to buy company stock at a discount.

I had seen The Friendly Russian’s write-up about his company’s killer ESPP, and my wife and I talked about whether that was something we wanted to take advantage of when the enrollment period for her company’s plan came around.

Recently, she got an email outlining the plan and announcing the next open enrollment period. So, I did what any good investor does: math.

What the heck is an ESPP?

An employee stock purchase program typically allows employees to buy company stock for a discount. There is typically a holding period, during which a chosen percentage of your pay is withheld until the program buys stock in bulk at the end of the holding period. The holding period is likely a few months to half a year, but could be longer.

In theory, this is good for both the company, which sells more stock to people with a vested interest in its success, and for the employee, who gets a discount on said stock.

Not all ESPP’s are created equal. The Friendly Russian’s, for example, notes the company stock price on the start date of the purchase period and again on the end date. The shares are then purchased at a 15% discount of whichever is the lowest price.

So, if you agree to purchase stock in January, and the company hits the skids and drops 20% by June when the purchase period ends, you get 15% off the June fire sale. But if you agree to buy in January and the stock goes up 20% by June, you get shares at 15% off the January price.

That’s a win-win for the employee, because you’re not taking a risk. You get a deal no matter which way the market swings, and if the market swings in the company’s favor you could get an incredible deal.

For the love of Excel

That’s not how my wife’s plan works.

With her plan, you agree to have a percentage of your income — up to 10% — set aside each month during the six-month purchase period. At the end of the purchase period, the company buys shares and gives you a 5% discount based on the stock price that day.

That’s a fine deal if you exercise a sale immediately.

For the sake of illustration, we’re going to say the stock price is $50, and she’s going to commit $800 a month to buy $4,800 in stock at the end of the holding period. She will then immediately sell it. Because of the way ESPPs are taxed, she’ll incur taxes equal to her ordinary income tax of 25% upon sale.

First, a 5% discount on a $50 share is $2.50 off. So, every share is automatically worth $2.50 more than the purchase price of $47.50.

If she allocated $800 a month, she would get 101 shares with the $4,800 set aside over the six-month purchase period. ($4,800 / $47.50 = 101)

If she immediately sold those shares at $50, she would get about $5,050 back for her $4,800 investment, for a gain of $250.

Once taxes are factored in, at a 25% ordinary tax rate, she’s left with about $188 ($250 x .75 = $187.50).

All in all, that’s not bad — she would basically realize a 4% guaranteed gain.

What about the downsides?

In order to get that gain, she would have to lock up $800 per month without access to it until the end of the six-month period. There’s an opportunity cost by doing that, and it’s not like the gain of less than $200 is too good to pass up.

What if, instead, we put that money into a Capital One 360 savings account, which has a .75% APY interest rate. There are other accounts paying even more, but we have CO360 and that’s sort of a middle of the road high-yield online savings rate right now.

If my wife takes her $800 after-tax money and socks it away in savings, the money compounds.

Here’s what that looks like:

There’s still a tax hit to the tune of 25%, so she actually would earn $7.88.

To eliminate the opportunity cost of locking up $4,800 to earn $188 in six months, she can instead earn $7.88 and have constant access to that money. From a percentage perspective, that’s a fairly sizable gap.

(Confession time: When I first ran the numbers, I forgot to convert the .75% APY to a monthly rate, which made it way more appealing to stick the money in a savings account. Then I took a step back to think about whether that made any sense logically. It didn’t. It pays to admit when you’re wrong.)

In the low-interest environment we’re in, 4% guaranteed is great. That’s the kind of return you could build a perpetual CD ladder on to basically maintain your nest egg in retirement. But at such a low overall dollar figure, it isn’t really blowing my hair back. You can make much more simply opening several new checking accounts and chasing sign-up bonuses. Plus, with that strategy you have access to the money should something better come along.

To ESPP or not to ESPP

If the details of my wife’s plan were more favorable for the employee — like The Friendly Russian’s — it would be a slam dunk. But with the plan being what it is, it feels like a small gain for no tax benefit and no access to the money in case of emergency or opportunity.

For that reason, I’m inclined to pass on the ESPP. The guaranteed upside is just too modest to outweigh the negatives.

Do you take part in an employee stock purchase plan? Would you choose differently if you could take part in my wife’s plan?