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Share price of State Bank of India closed at Rs 2920.9 on Wednesday and on Thursday it closed at Rs 297 after the stock split. A number of retail brokers received calls from their clients, who do not own the share, if they should buy SBI now that the price has come down. At the same time brokers are having a tough time explaining to their clients who are shareholders of SBI, on why the stock price has gone down sharply and why were they not informed about it?
Price adjustments due to stock splits and bonus issues are concepts that a broker finds it difficult to explain to his client. For a retail investor, the sharp fall in share price makes the stock affordable, at the same time, it leaves a feeling of loss of respectability for its existing holders.
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The main reason a company announces stock split is to attract more investors, especially retail ones. Institutional investors generally see through the game plan and is more concerned about the value at which the stock is available rather than the price.
Assume there are two investors Ajay and Vijay. Both wanted to make an investment of Rs 30,000 in SBI. Ajay bought the shares on Wednesday, the last day before the split date. Ajay ended up buying around 10 shares, at Rs 2,900 per share, with some change left from his available funds of Rs 30,000. Vijay thought he was smarter and waited for the stock to split and bought it on Thursday. For the same amount of Rs 30,000, he could buy 100 shares at Rs 290 per share.
Value wise, both have bought the same amount of shares though temporarily it might look like Vijay has more shares. But by the end of the week when the two investors compare their demat statement, identical shares will be reflected. Ajay’s share holding would show that he holds 100 shares of SBI rather than the 10 he bought but his holding value will be the same as that of Vijay.
This is because shares of all the shareholders would be split in the same ratio without impacting the value of holding, irrespective of the date of purchase.
Fundamentally speaking, value of the company or market capitalisation does not change on account of a stock split. Financial ratios get adjusted according to the bloated number of shares. Thus if a stock had an earnings per share (EPS) of Rs 90 before announcing a 10:1 split (10 shares for every one held), the new EPS will be Rs 9. Similarly dividend for every share will also reduce proportionately.
The only reason stock splits are done is to attract new investors and increase liquidity of the shares in the market. Value of the company does not change.
