How an employee stock purchase plan works

An employee stock purchase plan lets you buy company shares out of payroll deductions at a discount. People call it an ESPP.

It works on a cycle called an offering period. You choose a percentage of pay to set aside. The money accumulates. At the end of the period it buys shares at a price set by the plan's formula, not by the market on that day.

Two features make the formula valuable.

A discount. The plan buys at a percentage of the market price rather than the full price.

A lookback. The price is taken from the lower of two dates, the start of the offering period or the end of it.

Put those together and the purchase price can be well below the share price on the day you receive the shares. An ESPP is something you pay for, the way an option is, and usually the part of equity compensation with the most reliable return.

Apple's plan states the rule directly. The purchase price per share shall not be less than the lesser of 85% of the fair market value on the offering date or 85% of the fair market value on the last trading day of the offering period.

The plan also sets the rhythm. Two offering periods commence each year, each of approximately six months' duration, and an offering period may not exceed twenty-seven months.

Now work the formula on stated assumptions. These prices are illustrative, not Apple's.

In the first case you paid $85 for something worth $150. That's $65 of gain on $85 spent, about 76%.

In the second case the share price fell by a fifth and you still paid $68 for something worth $80. That's about 18%.

That's the point of the lookback. It takes the lower of the two dates, so a falling share price resets your purchase price downward instead of leaving you stranded above the market.

The trap is not enrolling.

An ESPP with a discount and a lookback is the most reliably profitable piece of equity compensation most employees are offered, and enrolment requires an action during a window. Miss the window and you wait for the next cycle.

The second trap is the cash flow. Your contributions come out of pay for months before any shares arrive. If the deduction is set at a level you cannot actually live on, you'll withdraw part way through, which is exactly when the discount does you no good.

The third is concentration. Your salary, your vesting RSUs and now your ESPP purchases all depend on one company. Plans often have a holding requirement, and the tax treatment of a quick sale differs from a long hold in ways that depend on your own circumstances. What this class gives you is the formula. The question of when to sell is worth putting to a professional.

And read your own plan. Apple's terms are Apple's. Discounts, period lengths and whether a lookback exists at all vary company to company, and the document is filed with the SEC.