Wednesday, October 28, 2009

Did your company just Split Shares?

Thought to do a separate post on share splits after getting a lot of comments/questions on this. see comments at here is a humble try to explain what a share split is.

What is a share split

When a company splits its shares, it agrees to issue additional shares to the existing share holders, but it doesn't intend to issue new shares like in a Follow-on Public Offer. The shares would come from the existing shares only and hence the face-value of the existing shares would be reduced. For example, if a stock has a face value of Rs 10, a two-for-one stock split will mean that there will be twice the number of shares as before with a face value of Rs 5 each for the new share. So if an investor owns 100 shares, he will have 200 shares after the split. In case of a five-for-one split, there will be five times the number of shares and the investor will own 500 shares for every 100 shares.

Fair enough, but how is this different from a bonus share

As discussed in the other post, in case of a bonus share, the current market price of the share decreases and the face value remains constant, where as in case of share split, both change. 

These 2 are inherently different in terms of accounting. A bonus reduces a company's reserves, converts it into equity capital and then issues additional shares from it. In absolute rupee terms, the equity capital (number of share multiplied by the face value) rises after a bonus. After a 1:1 bonus, the equity capital will double.
In a split, the absolute rupee capital is maintained at the same level and the reserves remain as before.

Merits of such an action
  • To make the share price affordable for more people to buy them in open market.
  • Increase in liquidity. It is now more readily available in the market to be traded.
What does it change

Practically nothing! A share split or a bonus changes nothing on the fundamentals of the company. It is much like cutting a 12 inches pizza into 8 pieces instead of 4. But investors love stock splits and bonuses. Empirical studies in the US do suggest that stock splits improve prices in most cases as investor sentiment improves. Bonus issues in India have also provided returns to investors.

Analysts do feel that both bonus and stock split indicate the management's conviction to sustain a higher profit growth to service the higher number of shares.


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