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How Stock Split Will Impact Equity Portfolio

 

How Stock Split Will Impact Equity Portfolio

 

The move results in an increase in the number of shares; the face value of each stock goes down. But total market value of the company remains unchanged

 

Public sector majors State Bank of India (SBI) and Punjab National Bank (PNB) have announced their stock split this week.

In the recent months, other major banks like ICICI Bank, Corporation Bank, Canara Bank and Axis Bank have announced their decision to go for stock splits. JK Tyre and Industries, too, has proposed a stock split, which will be taken up at its board meeting on Thursday. While stock splits may make headlines, it really does not make any huge difference to investors.

Stock splits or bonus do not change the fundamentals of a company. It's just that one stock with a face value of . 1,000 will now become five stocks ` worth `200 each (that is, if the split ratio is 1:5). If you owned 5% of a company, your holding will remain the same. Only the number of shares held will go up. Public sector majors State Bank of India (SBI) and Punjab National Bank (PNB) have announced their stock split this week.

In the recent months, several other major banks like ICICI Bank, Corporation Bank, Canara Bank and Axis Bank have announced their decision to go for stock splits.

Understanding Stock Split

A stock split simply results in an increase in the number of shares -correspondingly, the face value of each stock goes down. The total market value of the company, though, remains unchanged. "It is done to improve liquidity of a stock if it becomes too large value in absolute terms over time. Most companies with long history on the bourses tend to have multiple stock splits over time to keep easy liquidity in their stock. For example, during its initial public offering (IPO) stage, the stock price is say  500. Now, suppose, in five years, the company turns in a good performance the stock price soars to . 5,000. It will become somewhat illiquid for retail investors to trade in. For instance, say a retail investor who holds five shares of this company wants to rebalance her portfolio such that she wants to sell her stocks worth ` . 12,000 in value.

This simple transaction becomes difficult in this case as she is forced to sell stocks worth either ` . 10,000 or . 15,000 in value (that is, closest to ` . 12,000). The stock split of 1:5 at this ` stage will bring the value of single stock down to ` . 1,000 per share, making it relatively simpler for retail investors to trade in it. Your share in the company remains the same.

Some retail investors associate large stock prices with costlier stocks. Though, in principle, they know that the specific value of the stock is irrelevant and only the change from that value after they buy is of significance, they psychologically feel "safer" to buy lower price stocks. Stock splits help companies by bringing their stocks in the "normal" range of stock prices for such investors.

Fringe Benefits?

While stock split announcements make it to the headlines often, from the investors' perspective, the impact is almost neutral. Theoretically, the only benefit retail investors definitely get from stock split is greater liquidity because of smaller denomination. In practice, sometimes (but not always), stock splits lead to a small gain in value of the holdings. Also, the affordability goes up for a retail investor. Similarly, the volume of transactions in the stock, too, could get a boost.

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