Stock split is dividing the existing shares in different ratios according to the reduction of the face value.
Too much to take?
Let’s step back and understand from the basics!
Stock Split Meaning
An investment in knowledge pays the best interest. An investment with knowledge in stocks could yield good profits.
Stocks date back to the Roman Republic and officially started trading in the 1600s and now are the backbone of the economies of countries across the world.
The face value of the stock is the actual value of the stock decided at the time of issuance.
With time, a stock may see an increase or decrease in its face value and in case the face value is decreased, the existing share base is divided based on different ratios/parameters leading to the concept of Stock Split!
When a stock split is introduced, it increases the number of shares in the secondary market but the market capitalization remains the same. The issue of bonus shares which increases the number of shares in the market is not the same as the stock split.
Stock Split Definition
Theoretically speaking, a stock split is the sub-division of the existing shares into multiple shares. The idea is to spread a larger number of shares in the market to boost the liquidity of the stock.
The overall valuation or market capitalization, however, sees no change in the value of the stock.
A simple and quick example of that would be that if there is 1 share of a company at ₹100, then after a stock split of let’s say 2 for 1, there will be 2 shares now, each valued at ₹50.
In both cases though, the valuation stays at ₹100.
Stock Split History
When a company believes that the market price of its stock is relatively high and this factor is stopping traders to buy and sell such a highly valued stock, then they go ahead with the stock split.
Historically speaking, there have been many companies who have taken this step and there are a few that have avoided this concept.
It works for a few, it doesn’t for others.
Here is a quick list of some of the stocks that have seen a stock split along with the market value of their stock price post-split:
Hero Motorcorp Ltd
12 March 2001
Dr Reddys Laboratories Ltd
10 October 2002
Balaji Telefilms Ltd
23 Sept 2002
TVS Motor Company Ltd
18 Dec 2003
H T Media Ltd
28 Dec 2006
HDFC Bank Ltd
14 July 2011
Bata India Ltd
7 Oct 2015
ICICI Prudential Gold ETF
15 Nov 2018
Reasons for Stock Split
The stock split is done by decreasing the face value of the share. The face value of the share is the value printed on the share like that of a rupee note. That is the base price of the stock.
Previously the face value for high-value companies like ACC and other companies used to be ₹100. Now the normal face value is only ₹10. Depending on the company’s performance the shares come public with a premium to the face value.
And therefore some of the equity goes public while the most remaining is held by the promoters to consolidate their ownership of the company.
Trading Of The Public Limited Stock:
Once some of the stocks are bought by the public including the mutual funds, institutions like banks, high net worth investors and public it starts trading in the exchange. If the performance of the company is extraordinary the stock price soars and constantly increases in the market.
At one point, it becomes high enough for investors and traders to buy or trade in it. Also, the brokerage charges shoot up with the increase in price. Hence a necessity of splitting the stock becomes necessary.
Ratio Of The Split In Stock:
According to the board of directors of the company, the stocks are split in various ratios according to the decrease in face values. It could be 2:1 with a decrease of the face value to ₹5 from ₹10.
That is each shareholder with 1 share of the company now has 2 shares. If the face value is reduced to 1 from 5 it is in the ratio of 5:1. For every one share, the shareholder gets five shares.
But the price will be accordingly reduced as per the ratio. It if it is 2:1 the price will be half of the price before the split.
Effects of Stock Split
As mentioned above, with the implementation of a stock split, the number of stocks in your portfolio for the affected company get multiplied as per the decided ratio.
If it is 2:1 and you have 100 shares in your portfolio, the count will become 200. Similarly, for 3:1, it will be 300 and so on.
Now, how does it impact business as usual?
Well, the stock split effects are at multiple levels.
For instance, the EPS or Earnings Per Share ratio gets impacted as per the split decision. That is if the split is 2:1, then the earnings per share also become half as compared to pre-share-split EPS.
This is for the simple reason that the earnings or profit per share will see a corresponding impact when seen at the overall earnings level.
For example, if the company earned $10 Million in a financial year with 100,000 outstanding shares. Then the EPS comes out to be ($10,o00,000/100,000) i.e. $10.
Now, if the stock split was decided at 2:1, then the outstanding shares become 200,000 and the EPS becomes ($10,o00,000/200,000) i.e. $5.
Having said that, overall earnings in your portfolio for the number of shares you have before and after the stock split won’t change.
Moving ahead, ratio such as Price to Earnings ratio will see no change as both the parameters involved here will see an equal movement in their respective values.
Stock Split Formula
To calculate the share price post stock split, you can apply this simple formula:
New Share Price = Old Share Price/Stock Split Ratio
Let’s take an example to understand this.
Let’s assume the stock was last trading at a price of ₹100. The company decided to go ahead with a stock split of 3:1.
Now, the new share price will be = ₹100 / (3/1) i.e. ₹33.33
Since you hold 3 shares now for the 1 share you held before stock split, the price of your share price will see a decline. Having said that the overall stock valuation will see no impact at all i.e. (₹33.33 X 3 i.e. ₹100).
Stock Split Example:
One of the best examples for an Indian company stock split is Infosys.
Its stock was listed in Bombay Stock Exchange (BSE) on 14th June 1993 at ₹145 against the issue price of ₹95 with a face value of ₹10. If somebody has bought 100 shares of Infosys at ₹95 or 145 amounting to an investment of ₹9,500 or ₹14,500 respectively at that time now they will be holding 34128 shares which are valued now of ₹2.11 crores at the current market price of ₹620.
The stock split in 1999 was to bring the face value from ₹10 to ₹5 and the bonuses issued by the company including the latest one on 12.9.2018 in the ratio of 2:1.
Stock Split Vs Bonus
As discussed above, a stock split results in further multiplication of your existing shares into a different number. Although the share value may change, it will not have any impact on the valuation of the overall shares in your portfolio. It won’t even impact your profit you might be currently standing at.
However, in the case of bonus shares, the behaviour is a little different for that fact that the bonus shares are additional shares provided to the existing shareholders. This, thereby, impacts the overall valuation of their portfolio positively.
Where a stock split impacts all new and current shareholders, the bonus shares impact the existing shareholders only.
Stock Dividend Vs Stock Split
The concept of dividend is completely different from splitting a stock. Let’s have a quick walkthrough of these differences from multiple fronts:
It is distributed to the investors in the form of equity stocks.
It is basically the division of the equity stocks.
It is issued when there is no cash liquidity in the company for issuance to the investors.
This one is issued when the market price of the stock is overvalued and needs to be reduced.
Stock dividend is issued from the free reserves of the stocks.
A stock split, when issued, increases the number of shares without impacting the value of the share in any form.
Shareholders get new shares allocated.
Existing held shares are further multiplied. No new shares allocated.
Advantages of Stock Split:
Investing in the right stock brings in stupendous returns by way of stock splits. It is an indication of the better performance of the stocks. The Face value may be reduced from 10 to 5 or even 1 but the market capitalization will remain the same.
The major benefit will be the increase in price after the stock split. Many kinds of research have confirmed that stocks which have undergone split have become successful and profitable for the investors.
Once the stock is split to one extent the company will start issuing bonuses which are a boon to the investors. This could multiply their investments to manifold levels.
Stock Split Risks:
Investing in the wrong stock will lead to a stock split reverse which is the opposite of the stock split and could have adverse effects.
The share prices will not have any appreciation and there is also barring of the stock from the exchanges.
This could result in a loss of a major part of the capital investment. Also for shares in the physical form for stock splits they have to be sent to the companies for name transfer and in other cases, there could be difficulty in receiving the physical shares in time for sale and many other reasons.
Stock Split is Good or Bad?
Well, it really depends on the way you look at it.
Of course, the first impression that you get out of a stock split is that the stock is doing well in terms of company expectations. That’s a good thing.
However, historically speaking, 80% of the companies that have done the stock split in the past 20 years or so, have not seen any huge movement in their stock price or performance as compared to its peers.
Thus, objectively speaking, it does not have much of an impact in the long run.
So, it is neither good nor bad. It just is!
The stock split is a boon or bane depends on the stock invested. The split stocks are considered the best stocks in the market. These splits always have a huge volume of improvement along with a tremendous rise in the stock price to benefit the investors.
The stock split does not change the fundamental value but changes the prices in favour of it with each stock split to benefit the investors. The bonuses after the stock splits are the real befitting reward to the right investment in these stocks.
The financial prosperity and with it a peaceful life is possible by choosing the right stock to invest.
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