Stock split announcement - Should you rejoice or panic?

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  • Mr Market
  • 20-Jul-2014

Stock split announcement - Should you rejoice or panic?


What is a stock split?


A stock split is an increase in the number of outstanding shares of a company by issuing additional shares to existing shareholders in a specific ratio. As an illustration, a 2-for-1 split which means that every shareholder with one share will be given an additional share.


Why do companies opt for a stock split?


Retail investors think of affordability of a stock in terms of the stock price. As an illustration, they would find the shares of MRF unaffordable as it trades at Rs. 24,400/share while shares of Apollo tyres would be deemed as affordable as it trades at Rs. 200/share. Thus, the perceived affordability of a stock in absolute terms facilitates a participation of a larger investor base. The below illustration will help put things in perspective:


Company


CMP*


Number of shareholders holding share capital <=1 lakh


Bosch


12,000


23,623


Kingfisher Airlines


3.3


2,33,242


*CMP as on 9th June, 2014


Kingfisher Airlines, which has almost reduced to being a speculative penny stock has witnessed ~10x retail investor participation vis-vis Bosch, a blue chip company with relatively sound business fundamentals. This perplexing contrast reflects that an expensive stock in absolute terms deters retail investor participation.


Some other companies which could opt for a stock split and are expensive in absolute terms are:


Company


CMP*


Price/ Book Value


MRF


24,400


2.7


Bosch


12,000


6


Tide Water Oil


10,635


2


Shree Cement


7,750


6


Page Industries Ltd.


6,030


25


*CMP as on 9th June, 2014



Why is a large shareholder base desirable?


A relatively large investor base has the following benefits:


  • It engenders greater transparency and flow of information due to greater public scrutiny
  • It leads to higher stock liquidity and marketability
  • It deters emergence of small groups of influential shareholders with sizeable control

Warren Buffett on stock splits


The 'Oracle of Omaha' has famously written in his Annual letter to shareholders that stock splits attract buyers inferior to existing class of sellers and short-term investors could accentuate erratic price swings unrelated to business developments.


Prospero Tree view - What should you do when your company announces a stock split?


Kaveri Seeds, a company engaged in the agri-business of developing hybrid seeds had announced 5-for-1 split in Jan, 2014 when its stock price was quoting at Rs. 2,038. After the stock split, the number of outstanding shares became 5x and the market price should have ideally quoted at ~Rs. 407, 1/5th of its then CMP of Rs. 2,038. However, the stock traded at >Rs. 407 levels.


Gruh Finance, a housing finance company, rallied 22% after its 5-for-1 stock split announcement. Post split, the number of retail shareholders increased by 32%.


These illustrations demonstrate that after a split, the stock price may appreciate due to the excitement around the event but it is important to note that the company's liquidity, solvency and profitability are not impacted with such events. There is no change in the fundamental value of the company.


Prospero Tree is of the view that a stock split event should not influence an investor's investment decisions as these events do not have any bearing on the company's underlying business fundamentals. Investors should be indifferent to stock split events and should make investment decisions solely on the company's fundamentals.



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