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Do stock splits add value to a scrip?

Share prices of companies that have gone for a split in the past 2 years have mostly risen. However, the picture is not clear in the long term. Hence, go by the fundamentals

Neha Pandey Deoras 

To make the best use of the sharp rise in the stock market this year, many promoters have announced stock split to infuse capital in their companies. Since January 1 this year, when the BSE's Sensitive Index or stood at 21,140.48, about 78 companies have announced stock split, show data from Capitaline. In this time period, the rallied nearly 26 per cent. Between May 16 and October 1, the has rallied 10 per cent and 53 firms proposed

The bulk of companies going for are from the mid- and small-cap segments - La Opala RG, Alkyl Amines and J&K Bank. Some big names include Axis Bank and Havells India. Some others like State Bank of India, Punjab National Bank, Bank of Baroda, Canara Bank and ICICI Bank have announced split recently. Actions like stock split and buyback offer little in terms of understanding for a small investor. Many wonder if it warrants an equal reaction from their end in terms of buying or selling a stock that announces a split.

What is a stock split?
It is a sub-division of that lowers the face value of the stock, and increases the number of outstanding shares. The split ratio might vary for different companies - 2:1, 10:1, 5:1. The day that the split is carried out is known as the record date. Subsequently, the shares start trading at the new price on the stock exchanges.

Stock split keeps the company's total capital base intact. Suppose the face value of one share of Company A is Rs 10 and the outstanding shares that have been issued are 10,000. If Company A declares a 2:1 stock split, it means that its shareholders will own two shares for every one held by them previously, but at half the face value. The company's outstanding shares will double to 20,000, while the face value per share will halve to Rs 5. So, if you owned 50 shares worth Rs 500 before the split, you will now have 100 shares worth Rs 500 after the split.

Why is a stock split done?
Stock split makes shares of a company cheaper. This will attract more investors to trade in the stock. Some term it as a play on the psyche of the investor. Arun Kejriwal, founder at Kejriwal Research & Investment Services, says, "Psychologically, a stock looks cheaper and this attracts investors and trading in the scrip. When a share's price runs up, smaller investors find it easy to enter or buy the stock and trading in the stock also increases, which may have decreased due to high prices." And, this is true not only for small investors but even the big ones are more inclined to buy a stock cheaper.

The split does not affect the value of investors' holdings. Similarly, the company's fundamentals don't change, with its earnings and equity capital base remaining the same. It is simply splitting higher denomination in to lower denomination. Since the stock split doesn't change anything for a company from a fundamental perspective, experts caution investors against buying such shares merely because they are cheap. They say investors should stay clear of companies, which use only to stay afloat.

How do investors benefit?
There are two views common about stock split: First, that such a move has no impact on share price. Second, stock splits push up the share price, as the demand for the shares increases after the move.

Kejriwal explains, "Say a stock with face value of Rs 10 is split, it quotes a price of Rs 5. Similarly, if the market price was Rs 100, it should quote Rs 50 after the split. However, in reality the stock price quotes higher. This means that move up post split, typically seven-nine per cent. Hence, even though theoretically stock splits are not supposed to add value to a stock, practically it does add value."

Out of the data for 20 companies, compiled by Business Standard Research Bureau, only seven companies' stock prices had slipped post stock split (see box). Axis Bank stock fell five per cent after split in July and J&K Bank fell 11 per cent after split last month. But many others have only gained. Southern Ispat stocks have gained 11 per cent after the split last month and Havells India gained six per cent post split August this year. Godrej Properties has gained 31 per cent between November 2013 (when stock split happened) and October 1, 2014. Asian Paints has gained 23 per cent between July 2013 and October 1, 2014. Relaxo Footwear gained 186 per cent since its split in November 2013.

Vikram Dhawan, director at Equentis Capital, points out that stock split can also improve liquidity in a stock, at least in the near-term. "As lot size of shares reduces, investors find a stock cheaper and flock to it. Thus, improving trading volumes in the stock and liquidity," he says.

Some experts opine that a stock split might not automatically result in benefits for investors, who bought the split share at a lower price. One possible reason for the increase in share price could be that a stock split provides a signal to the market that the company's share price has been increasing prior to the split and people assume this growth will continue in the future.

Piyush Garg, chief investment officer at ICICI Securities, is not enthused about stock splits, as no fundamental factors change for a stock. Hence, it is of little relevance for small investors, he adds.

Some feel a lot has also to do with the company that is announcing a split. In 2011, 28 companies split their shares - HDFC Bank, Titan Industries, Rallis India, Cox & Kings, Rain Commodities and Bajaj Corp. However, close to two-thirds of these companies failed to perform in the equity markets, as in some cases, shares were beaten over 70 per cent.

Should you look forward to a stock split announcement? You can't be sure always. It doesn't matter in the long term. Hence, investors should focus on a company's fundamentals and growth prospects. If a company is doing well, its shares will also benefit. If you are not already a shareholder, you can always buy its shares at a lower price after the split.

First Published: Sun, October 05 2014. 23:07 IST