What’s New
Procter & Gamble employees who are normally eligible for the LTIP award in February, will now be receiving the award in the preceding October. Eligible employees have the opportunity to choose either RSU’s, Stock Options, or a combination of both in 25% increments. Consult your P&G compensation department and online resources for your award choice deadlines and official details on your benefits.
Time on Your Side
When considering how to take your next LTIP award, there are several matters to consider. For instance, you will want to consider the current stock price, valuation, and the advantages of a more certain future value that restricted stock units provide. You will also want to consider both the advantages of leverage and the possibility of a zero value for stock options, along with the advantages of a ten-year expiration.
How Leverage Works & Risks of Leverage
Think about how a mechanical lever works when lifting a heavy object. The lever amplifies the input force to provide a greater output, thus making a heavy object seem much lighter and easier to lift. A leveraged investment can be thought of in a similar way. A certain input (investment) can be amplified to produce a larger output (investment gain). Be aware however, that a leveraged investment can also result in zero gain and in some cases a complete loss of your initial investment.
An Example
To better understand how Employee Stock Options and Restricted Stock Units (RSU’s) work, consider these fictitious examples. Please note that these examples exclude dividends and the impact of taxes. In this example, two employees, ‘RS’and ‘SO’, each earn a $10,000 Long Term Incentive Program (LTIP) award from company. At the time the LTIP award is granted, company stock price is $100 per share and the company’s corporate cost per stock option is $15 per share.
RSU’s
Employee ‘RS’ chooses to take his award as 100% RSUs, and he receives 100 shares of Restricted Stock Units ($10,000 divided by $100 price per share). The RSUs vest 3 years from the grant date and are paid to the employee on that date. Over the 3 years between the grant date and the vest date, shares of company compound 6% annually. On the vest date, employee receives 100 shares of company stock valued at $119.10 each ($100 price per share compounded at 6% annually for 3 years) and $11,910 in total value (100 shares multiplied by $119.10 price per share).
Over the following 7 years, company stock compounds 6% annually and ten years after RS’s award was granted, company stock price is $179.08 per share. Thus, RS’s initial $10,000 RSU award and subsequent investment is worth $17,908.48 (100 shares multiplied by $179.08 price per share).
Employee Stock Options
Across the hallway, employee chooses to take her award as 100% employee stock options. Employee understands that taking her award in stock options may ultimately be worthless if the price per share of does not rise above her $100 grant price, but she is willing to take the risk. Thus, receives the future option to buy 667 shares of company ($10,000 divided by company $15 cost per share) at a grant price of $100 per share. Employee SO’s options vest in year 3 and expire in 10 years.
At the 3-year mark, ‘SO’ reviews her option value to determine whether to execute her buy options yet. She performs the following calculations: 667 shares of multiplied by the $100 per share grant price equals a $66,700 purchase price. Next ‘SO’ applies the year 3 share price of $119.10, multiplied by her 667 shares to get a current gross value of $79,439.70. Lastly, ‘SO’ subtracts her purchase price from the gross value to get a net gain of $12,739.70 ($79,439.70 value minus $66,700.00 purchase). Despite her gain after 3 years, ‘SO’ considers the fact she has 7 more years before expiration, and she decides to wait for a future opportunity.
Before her options expires in year 10, ‘SO’ sees the share price of is now $179.08, and she executes her option to buy 667 shares at $100. ‘SO’ performs the calculation again. She multiplies her 667 shares by $179.08 price per share to get the gross value $119,446.36. Next she deducts her $66,700 cost to purchase the shares resulting in a net pre-tax gain of $52,746.36.
In our example, ten years after the grant date, both employees ended up with gains beyond their initial $10,000 award. Employee ‘RS’ initially took RSU’s and ten years later had a net investment worth $17,908. Employee ‘SO’ initially took stock options and ten years later had a net investment worth $52,746. Both relied on the same underlying investment (company “C†common stock) that gained a steady 6% annually, but the impact of leverage gave ‘SO’ almost 3 times the gain over the full ten-year period.
Make Decisions with Confidence
There are risks and rewards associated with any type of investment. Understanding how options and RSUs work, the risks, the potential for gains, and which type of award may be most beneficial toward your goals, is critical in determining how to take your awards. Consider hiring a professional Investment Adviser at Schmitt Wealth Advisers for advice and perspective as you seek to optimize your award choices, and most importantly, to help as you plan for and work to achieve your overall financial goals.
This material is provided by Schmitt Wealth Advisers for informational purposes only. It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product. Opinions expressed by Schmitt Wealth Advisers are based on economic or market conditions at the time this material was written. Economies and markets fluctuate. Actual economic or market events may turn out differently than anticipated. Facts presented have been obtained from sources believed to be reliable. Schmitt Wealth Advisers, however, cannot guarantee the accuracy or completeness of such information. Past performance may not be indicative of future results.
