Should I Buy My Company’s Stock? AREVA’s ESPP
Investing in Your Company’s Stock by Joe Eskridge
If your company grants you the right to participate in an Employee Stock Purchase Plan (ESPP), your company has given you an option (the right but not the obligation) to purchase shares in company stock at fixed intervals. Generally you can accomplish this through payroll deduction. Your company may grant an ESPP at a discount. Any discounted amount will be taxed as ordinary income when you sell the stock.
If you know the fundamental value of your company’s stock and think it is under- or, at least, fairly-valued, exercising your right to purchase stock at a discount can result in a positive outcome because of the potential for higher returns. However, you should buy your company’s stock based on its intrinsic value; not because you are getting a discount. After all, a 20% discount on something that is over-valued means you may break even at best or, at worst, lose money.
Another advantage of investing in your company’s stock is that you typically have more knowledge of the company than the average investor. For example, you may be a better judge of your company’s business model and potential growth prospects. By having knowledge of how your company’s business works, you may have more insight into where the company is headed.
To determine whether investing in company stock is right for you it is important to also consider some of the downsides. These include unique conditions vis-à-vis owning your company’s stock, a loss of objectivity, a lack of diversification and greater risk of loss.
In the case of one local employer that has granted an ESPP at a discount, its employees face a mandatory, multi-year holding period (unless an employee qualifies for a company-defined, early exit event). A company can experience a myriad of fortunes and misfortunes over a multi-year holding period. Additionally, this company’s employees will use their U.S. dollars to purchase company stock that is priced in Euros on a foreign stock exchange. This introduces exchange rate risk.
Another consideration is whether your loyalty to your company biases your decision to participate, and to what extent, in an ESPP. On the one hand, your loyalty to your company may enhance esprit-de-corps at the office. On the other hand, as an employee loyal to your company, it may be difficult for you to remain objective about the facts of your company. Do you really know the intrinsic value of your company’s stock? Do you truly have more insight into where your company is headed? Be wary of introducing bias into your analyses and carefully ensure your decision to participate in an ESPP is grounded in objective reasons.
Another concern is that you may derive your primary source of cash flow from the wages your company pays you. Your wages create a “stake in the sand” or vested interest in the success of your company. That interest is just like equity ownership. Investment professionals call this your “sweat equity”. Investing in your company’s stock increases your overall ownership in your company. While this may be a good thing at times, it can also mean that you are losing diversification if you allocate a large portion of your savings to your company’s stock. If your company is not doing well, this means that your portfolio could see deeper downward swings, affecting overall growth.
By owning a larger amount of your company’s stock, you could also experience greater risk. News may come out that is not favorable to your company and cause a serious decline in the stock. Maybe the industry is experiencing a major slowdown that can lead to precipitous declines in the stock. Regardless, you will be hit harder because you own more shares. This kind of volatility will no doubt play a role in how you will plan for retirement. While you want to be able to participate in the upside, it also is important to keep some kind of balance so that if the company stock does decline for whatever reason, you will be protected.
As an employee, the maximum amount that you would want to investin your company stock is no more than 10% of your overall portfolio; even 10% might be too much risk for most. (Keep in mind that most professional money managers rarely invest more than 5% in any individual company.) That being said, some common sense should be applied. If you are closer to retirement or any other time when you will need the money, you may want to reduce your allocation even more. In doing so, you are reducing your risk by keeping only a certain amount of your portfolio invested in company stock and then reducing the amount that you own as you move closer to the time that you will need the money.
Ultimately, long before you consider participating in your company’s ESPP, you should have a portfolio that is comprised of a mix of equity and fixed income investments. At HSC Wealth Advisors, our investment philosophy is rooted in ETFs and no-load, no-transaction-fee mutual funds. Some of our clients participate in ESPPs and we work closely with them to ensure they are protected should their companies’ stocks prove less than satisfactory. Our disciplined approach to asset allocation and diversification serves our clients well.