Does the Stock Split Enhance Value?
A stock split is a decision made by the company management to split the shares into multiple shares. A company may split its ₹10 shares to two shares of ₹5 each. Companies resort to a split when the price per share has gone beyond the range deemed appropriate by investors. It is a pure psychological game. An investor is likely to feel a share trading at ₹2,000 (face value ₹100) more expensive than a share trading at ₹150 (face value ₹5). He does not understand that a share with a face value of ₹5 is trading at 30 times the face value, while the other one is trading at 20 times. We often end up comparing apples to oranges.
Investors often greet the stock split decision with extreme joy, and the price rises after the split. The reasons are more in human psychology than in economics. Speaking logically, a split should not add any value. When a company which has 1 crore shares of ₹10 each splits its shares into ₹5, it would now have 2 crore shares of ₹5 each. The pizza remains the same. Instead of splitting it into 4 slices, you split it into 8 slices. Now there are more slices; perhaps more people can share it. It’s the same with the stock split. Earlier, I held 500 shares; now I have 1,000 shares. I am likely to be tempted to sell the ‘additional’ 500 that I received because of the split (even though it is nothing more than splitting the pizza slice). This generates more floating stock in the market at an affordable price. More floating stock and lower price—the market is likely to receive it favourably.
When a split happens, the trading price of the share is adjusted in the markets. Thus, a share trading at ₹100, when split in two, should trade at ₹50. However, as shown above, cognitive factors often drive the price higher.
Some people like to buy the shares on the split announcement and sell them after the split. There is no real unlocking of value in the split, so it is a non-event as far as a value investor is concerned. Split changes none of the economics of the share; it remains the same share, just cut into a lower denomination. Knowing a split is often welcome by investors, unscrupulous managements often resort to stock splits at the peak of the boom so that the psychology keeps driving their stock prices higher, though prudent management would also resort to the stock split to keep the price in the range. Some of these companies have split so many times that the face value is now ₹1. A split less than ₹1 is not permissible.
There are notable companies which understand that split creates no real value. In the present market scenarios, institutional investors dominate the market. A split is inconsequential to them. A split is of no consequence to retail investors too since there is no marketable lot in a digital environment and you are free to buy just one share. Unless the price of one share itself is beyond your reach, Berkshire Hathaway has never split its shares, and the price is beyond the reach of many. On the date of writing this, I checked up Berkshire’s price, and it was trading at $15,525 (₹3,23,935). In 1996, with Berkshire Hathaway selling for $33,000 a share, outsiders planned to buy Berkshire shares and resell them to investors in $1,000 pieces through unit investment trusts. Not wanting small investors to pay sales charges and other administrative expenses that such trusts would entail, Berkshire Hathaway issued class B shares (dubbed Baby Berkshires) each without voting rights and worth 1/30 of the regular class A shares. In January 2010, they split class B shares 50 to 1, making each worth 1/1,500 the value of class A shares. The latest trading price of Berkshire B is $9.67.
In the Indian markets, the current trading price of MRF is ₹65,129 (face value ₹10), Page Industries ₹29,650 (FV ₹10), 3M India ₹19,440 (FV ₹10), Eicher Motors ₹22,500 (FV ₹10).
(Dr Tejinder Singh Rawal is the author of the best-selling book Loads of Money: Guide to Intelligent Stock Market Investing: Common Sense Strategies for Wealth Creation)
Investors often greet the stock split decision with extreme joy, and the price rises after the split. The reasons are more in human psychology than in economics. Speaking logically, a split should not add any value. When a company which has 1 crore shares of ₹10 each splits its shares into ₹5, it would now have 2 crore shares of ₹5 each. The pizza remains the same. Instead of splitting it into 4 slices, you split it into 8 slices. Now there are more slices; perhaps more people can share it. It’s the same with the stock split. Earlier, I held 500 shares; now I have 1,000 shares. I am likely to be tempted to sell the ‘additional’ 500 that I received because of the split (even though it is nothing more than splitting the pizza slice). This generates more floating stock in the market at an affordable price. More floating stock and lower price—the market is likely to receive it favourably.
When a split happens, the trading price of the share is adjusted in the markets. Thus, a share trading at ₹100, when split in two, should trade at ₹50. However, as shown above, cognitive factors often drive the price higher.
Some people like to buy the shares on the split announcement and sell them after the split. There is no real unlocking of value in the split, so it is a non-event as far as a value investor is concerned. Split changes none of the economics of the share; it remains the same share, just cut into a lower denomination. Knowing a split is often welcome by investors, unscrupulous managements often resort to stock splits at the peak of the boom so that the psychology keeps driving their stock prices higher, though prudent management would also resort to the stock split to keep the price in the range. Some of these companies have split so many times that the face value is now ₹1. A split less than ₹1 is not permissible.
There are notable companies which understand that split creates no real value. In the present market scenarios, institutional investors dominate the market. A split is inconsequential to them. A split is of no consequence to retail investors too since there is no marketable lot in a digital environment and you are free to buy just one share. Unless the price of one share itself is beyond your reach, Berkshire Hathaway has never split its shares, and the price is beyond the reach of many. On the date of writing this, I checked up Berkshire’s price, and it was trading at $15,525 (₹3,23,935). In 1996, with Berkshire Hathaway selling for $33,000 a share, outsiders planned to buy Berkshire shares and resell them to investors in $1,000 pieces through unit investment trusts. Not wanting small investors to pay sales charges and other administrative expenses that such trusts would entail, Berkshire Hathaway issued class B shares (dubbed Baby Berkshires) each without voting rights and worth 1/30 of the regular class A shares. In January 2010, they split class B shares 50 to 1, making each worth 1/1,500 the value of class A shares. The latest trading price of Berkshire B is $9.67.
In the Indian markets, the current trading price of MRF is ₹65,129 (face value ₹10), Page Industries ₹29,650 (FV ₹10), 3M India ₹19,440 (FV ₹10), Eicher Motors ₹22,500 (FV ₹10).
(Dr Tejinder Singh Rawal is the author of the best-selling book Loads of Money: Guide to Intelligent Stock Market Investing: Common Sense Strategies for Wealth Creation)
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