WHAT IS STOCK SPLIT
Stock splits are one of the most common corporate actions in India and across the world. A stock split or share split is about reducing the par value of a stock. For example, reducing the par value of the stock from Rs.10 to Rs.5 is a 2:1 stock split and reducing the par value from Rs.10 to Rs.1 is a 10:1 stock split. Having understood the stock split meaning, let us get into detail about what is a stock split.
Stock splits are normally done to reduce the market price of the stock and bring it into a more popular range. All stock splits and share splits are value-neutral in that they do not impact the value of the company in any way. Let us now look at the share split meaning and its implications in greater detail.
WHAT IS STOCK SPLIT OR SHARE SPLIT
A Stock split happens when a company decides to split one share of its stock into more shares. The very name of stock split or share split is so suggestive that you cannot miss it. Post the stock split, the total combined value of the split shares still equals the price of the previous one share. Let us understand this share split story with an example.
| Particulars | Pre Stock Split Data | Post Stock Split Data |
|---|---|---|
| The ratio of stock split at 10:2 | Old face value of the stock – Rs.10 | New face value of the stock – Rs.2 |
| Number of shares outstanding | 5 crore shares | 25 crore shares |
| Total Net Profit of the company | Rs.55 crore | Rs.55 crore |
| Earnings per share or EPS | Rs.11 | Rs2.20 |
| Price-earnings ratio or PE ratio | 25 times | 25 times |
| The intrinsic value of the share | Rs.275 per share | Rs.55 |
| Stock price | Rs.280 | Rs.60 |
| Market capitalization | Rs.1,400 crore | Rs.1,500 crore |
In the above illustration, if you are a shareholder, your shareholdings are up 5 times but your price is down to approximately one-fifth. That means; the impact is almost marginal. That is why it is said that the stock split is value-neutral. However, there is an important point to note. When a high-priced stock is split, the price comes into a more popular range so more retail investors get interested in the stock and this higher demand takes the price higher. However, in terms of the valuation of the company, the stock split is still valued neutral
To cut a long story short, in a stock split, investors who own stocks still have the same amount of money invested, but now they own more shares at a proportionately lower price. But as we saw above the value may not exactly be the same and normally, the stock split tends to make the stock more valuable due to its wider reach. That is normally one of the most popular reasons for companies to do a stock split.
How exactly does a Stock Split Work?
Most companies grow over time and that makes the stock price trade higher. At some point, the price of the stock may just be too expensive for investors to afford, and that has a bearing on the market liquidity as there are fewer and fewer people capable of buying a single share. How many retail investors do you see buying one share of MRF for Rs.80,000? Do you get the answer and the justification for a stock split?
Let us once again remember that stock splits don’t add value as they are value-neutral. The number of shares goes up by a multiple and the prices come down almost proportionately. However, it has been observed that when solid companies do stock splits, they tend to be value accretive in the long run. To an extent, it is due to the stock split as it brings the stock in a more popular tradable range.
Understanding stock split ratio
Normally, the par value of Rs.10 is split to either Rs.5, Rs.2, or Rs.1. These are the most common types of stock splits.
How is a stock split advantageous?
There are 4 ways in which a stock split is valuable to the investors in stocks.
- Stock splits improve liquidity. When a high-priced stock is split and brought into a more popular trading range, the liquidity improves.
- Stock splits make portfolio rebalancing easier since lower-priced stocks are more liquid and hence easier to sell and churn.
- This is more psychological, but the stock split reduces the risk for an option buyer optically as the option premiums come down.
- If not all the cases, stock splits tend to be price accretive in most cases due to improved liquidity.
WHAT IS BASKET ORDER
Basket orders are for a portfolio of stocks, where the investor allocates an overall amount to the basket and the system accordingly buys individual shares in the appropriate proportion as mentioned. It is possible to buy and sell a basket of stocks in bulk through basket orders. Basket orders charge concessional brokerage in the stock trading app.
WHAT ARE DIFFERENT TYPES OF EQUITY SHARES
In India, you still don’t have concepts like Class-A and Class-B shares like in the US. But you have shares and DVRs which have differential voting rights. You can also have fully paid up shares and partly paid-up shares in the market.
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Frequently Asked Questions
One of the most popular reasons for a stock split is to bring the stock in a more acceptable trading range for retail investors. For example, if a stock is quoting at Rs.5,500, then not to many retail investors. Instead, if the company does 10:1 stock split, the price will come down to Rs.550 and make it more reachable for retail investors.
Reverse stock split is also called stock consolidation and is the opposite of stock split. In stock split, for example, you reduce the face value of the share from Rs.10 to Rs.5. In reverse stock split, you can take the par value from Rs.5 to Rs.10. Reverse stock splits are not as common as stock splits.
You don’t have to do anything. If your shares were in your demat account on the record date of the split, then split shares with a new ISIN number will be automatically credited to your demat account.
Stock splits are value neutral, in the sense that they neither increase value of the company nor reduce it. The only thing is that they bring stocks in a more acceptable trading range and improve demand.