A stock split reduces the value of a share to the extent of the split, thereby making high priced stocks accessible to retail investors and shareholders, at a reasonable price, and in greater quantities. Ideally, a stock split is a non-event, as it does not affect a company's equity, or its market capitalization. It’s just that the number of shares outstanding change, so a stock split does not directly change the value or net assets of a company.
Explains Rishabh Parakh, Chief Gardener, Money Plant Consultancy, a leading Tax & Investment Advisory services, “Stock splits are intended to bring down the share price level so that it becomes affordable. However, in reality, it only looks affordable, but in actual they are not. It does not create any additional value and can be termed as wealth neutral,” adding that since the shares now seem more affordable, post the split, small investors are often lured. “What they don’t realize is that the underlying value of those shares has not changed. Post stock split, the share prices, in most cases, does rise mainly because most investors are actively buying the stock. This results in a boost in demand and rise in the share price.”
Parakh also notes that the other reason for this price rise is that there is a perception in the market that the rise in stock price is due to the company growth and this will continue in the future, which further tends to increase the price.
Market participants are of the view that some small companies do use stock splits mainly to evade taxes and manipulate the market. Markets regulator, Securities and Exchange Board of India (SEBI) has taken note of this issue and is working towards setting a floor price as a qualifier for companies opting for stock splits, says Parakh. “SEBI is also working on introducing guidelines on stock split to curb the manipulation. It has proposed that the split can be only allowed if the stock price is above Rs 500,” he added.
Experts note that misuse of stock splits is a serious concern and needs to be looked at, but at the same time, curbing stock splits for shares that are priced below Rs 500 could create liquidity issues. Last year, when stock markets were riding high, most promoters used this opportunity to make high-priced stocks available at reasonable prices and in greater quantities to retail investors. Leading banks such as State Bank of India (SBI) went for a stock split, last year to enhance broader investor participation, especially retail participation, as the increase in demand would enhance the price to earnings ratio. Promoters of IT companies were seen going for a stock split, back in later 1990’s. Similarly, real estate companies too were announcing stock splits in 2006-2007.
Market experts advise that investors should study the fundamentals of the company before buying the stocks, post the split. If the fundamentals of the company look strong, one can go ahead.
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