Benefitting from stock splits

Ideally, it should be a zero-sum game but in reality, investors stand to gain due to price rise and higher liquidity

Buying a single stock of a company at Rs 5,000 may deter many. But if it costs Rs 500, investors would show more interest. That is the simple rationale behind a stock split. How does it work? Suppose a company with a face value of Rs 10 splits it to 1:5, it means that a person holding 100 shares of the company will now hold 500 shares of the same company. But, the price of the stock will come down to Rs 2 apiece, keeping the value of shares (Rs 2x500) same as before (Rs 10x100 = Rs 1,000).

Managements of good companies choose to go for this option when the share price of a company becomes very high, especially in a rising market, giving rise to fears that the stock has become inaccessible to regular investors and only institutions or high networth individuals can move the stock price. A wider shareholding base helps the company because there are lesser chances of a sharp rise or fall in its price.

Since the beginning of the year, 48 companies have taken the call of share-split. And these include some of the prominent names are Havells’ India, Axis Bank and others.

Says Rishi Nathany, director, Touchstone Wealth: “Whether I hold one stock of Rs 5,000 or 10 stocks of Rs 500 each should not make any difference but it does because of two reasons. One, cheaper stocks means more people are willing to put money on it. Two, there is an increased liquidity.” There has been a sharp spurt in trading volumes of the stock.

Financial experts say that since good companies typically go for such splits, investors or traders take the cue. Even traders like stocks with higher liquidity.

For example, if a stock is priced at Rs 5,000 it is unlikely to be too volatile for the trader’s liking. To move the stock by 10 per cent or Rs 500 in either direction requires a substantial amount of money. On the other hand, a stock of Rs 500 can be easily moved either ways, thereby giving the traders an opportunity.”

Importantly, companies which have already seen sharp movement of their stock prices resort to this. This implies that there is already enough investor interest in the stock. The split is just to keep the good mood going.

But it’s not all rosy. Says another broker: “The impact of the move is seen on the trading floor because with more shares of the company available, market forces come into play more forcefully. If the fundamentals are good, the stock will trade up and if not, there will be a fall.”

Financial experts warn that if you already own shares of a company, there is no need to hurry and sell or buy if the company announces a split. Also, if you haven’t invested in the stock but the news of a split interests you, still there is no need to buy the stock immediately. Give the stock around two-three months to settle down before taking the call to buy or sell. “Once the split is announced, there is a euphoria that gets built into the price immediately. So one should wait for same time,” says Nathany.