Aboun 50 listed companies have initiated the corporate action of stock split, the market term for dividing an existing share into multiple units. As an investor, should you invest in a stock before or after it is split? Stock splits immediately result in a rise in the number of outstanding shares by a specific multiple.
But the total value of the shares remains the same as no real value is added as a result of the split.
For instance, in a 1:5 stock split an investor will own five times the number of shares she originally owned and the company will have five times the number of shares outstanding. Stock split also leads to a rise in trading volume, as the stock 'appears' cheaper, and a drop in volatility on the counter.
The problem is, the market tends to react to a stock split decision with a lot of euphoria and common investors show the tendency to fall for it.
Retail investors seem to believe a stock split is a positive development. Even though there is no effect on the company's fundamentals, people believe in the myth that the stock price will move up and attain the pre-split level quickly. But in reality, the only effect it has is that it leads to a rise in trading volume.
A price analysis of the stocks that have been split in recent times suggests some stocks did show an upward trend following the announcements. In some cases, the stocks even touched 52-week highs. For instance, shares of Astral Poly Technik hit Rs 234 on May 24 after the company's board recommended a 2for-1 stock split at the time of announcing its March quarter results.
In other cases, the soon-to-be split stocks saw price appreciation even when the broader market fell.
This happened on the counters of Ram Ratna Wires, South Indian Bank, English Indian Clays and Bodal Chemicals, where the stocks rose between 10 to 21 per cent since the time a stock split was first proposed. The Sensex fell between 5 to 7 per cent in the same period.
The bullish trend in the prices (for stocks that announce stock split) usually remains only till the record date.
But there were also cases like Farmax, where the stock fell 11 per cent (till May 27) since the time of announcement (May 11) of a probable stock split. Sensex has fallen only 5.5 per cent in the same period. Bain Capital-backed Himadri Chemicals has lost over 4 per cent (since May 18 till May 27)) while Sensex has lost just 1 per cent.
Stock split may not be the only reason for the apparent out-performance or under-performance of these counters. There could be important fundamental factors such as results or technical factors such as resistance levels.
Why do more and more companies go for stock split?
Stock split makes a counter look cheaper and, hence, it becomes more liquid. While `cheaper' stocks are more popular with retail investors, higher liquidity on a counter tends to draw institutional investors. Stock split can have a positive impact on prices if the counter generates good interest among FIIs, who may have been avoiding the stock earlier due to lack of liquidity.
Also, as long as there is no corporate governance issues, a counter tends to perform better compared with its peers after a stock spilt. But investors should be beware of case where the track records of the promoters are not very clean, specially companies in the B2 and Z category stocks of BSE. In such cases, investors should avoid the temptation of buying these stocks.
At the peak of bull run in 2007, a large number of companies with dubious track records used this carrot of stock split to attract gullible investors. They were left high and dry when the market crashed in early 2008. Also, one should avoid stocks that have been re-listed after a long gap and then a stock split or a bonus issue is announced. This could just be a trap of market makers.
As an investor, if you are entering a counter because of a stock split, be ready to hold it for the long term.
Because a rise in liquidity and lower impact cost are some of the factors that can get a higher multiple for a stock, but that happens only in the long run. There are over 80 stocks on the BSE that have market prices over Rs 1,000. Shares of MMTC, Dalal Street Investments, MRF, Bombay Oxygen, Ravalgaon Sugar, Veritas (India), Crisil and Tide Water Oil are quoting at over Rs 5,000 a share.
Some of these may go for stock splits in future. On May 27, Britannia announced 5-for-1 split for its shares trading at Rs 1,690 apiece.
There is no tax implication in a stock split. A stock split is tax neutral. When the shares are sold, the capital gains tax implication is different from what is applicable to bonus issues. In case of a split, the original cost of the shares also gets reduced.
If an investor bought 100 shares of a company at Rs 1,500 a share, and if the company goes for a 1:5 stock split, the share price will get reduced to Rs 300, thereby keeping the total cost constant at Rs 1,50,000.
