Monday, April 04, 2011

Stock split ...... What's that?

Sure does sound funky. But a stock split happens quite often.
And, what it means is rather direct. Your stock actually gets split.
To understand what a stock split is and how it impacts you, read on.

  • First understand what a share is
Any business has a lot of assets: machinery, buildings, land, furniture, stocks, cash, investments. It will also have liabilities. This is what the company owes other people. Bank loans, money owed to people from whom things have been bought on credit, are examples of liabilities. Take away the liabilities from the total assets, and you are left with the capital. Assets - Liabilities = CapitalCapital is the amount that the owner has in the business. As the business grows and makes profits, it adds to its capital. This capital is subdivided into shares.
So if a company's capital is Rs 10 crore (Rs 100 million), that could be divided into 1 crore (10 million) shares of Rs 10 each. So, if you own 100 shares of Gujarat Ambuja Cement, for example, you own a very small part -- since Gujarat Ambuja has millions of shares -- of the company. You own a share of its assets, its liabilities, its profits, its losses, and so on.
  • How is this share valued?
If the company has divided its capital into shares of Rs 10 each, then Rs 10 is called the face value of the share.
When the share is traded in the stock market, however, this value may go up or down depending on supply and demand for the stock. So the price of Company X shares will go up and down depending on the demand for Company X stock.
If everyone wants to buy the shares, the price will go up. If nobody wants to buy them, and many want to sell the shares, the price will fall.
The value of a share in the market at any point of time is called the price of the share or the market value of a stock. So the share with a face value of Rs 10, may be quoted at Rs 55 (higher than the face value), or even Rs 9 (lower than the face value).
If the number of shares in a company is multiplied by its market value, the result is market capitalisation.

  • Now you will understand what a stock split is
The face value of a company's shares may be Rs 100.The company may want to change the face value. So it will take one share of Rs 100 and make it two. So now, the face value of each share is Rs 50. If you owned one share, you will now own two. So basically, the number of shares have increased. But, the number of shareholders have not. The number of shareholders are the same. It is just that the number of shares they own has doubled.

  • Who will get the additional shares?
The company announces the split ratio on a particular date called the record date. All shareholders whose names appear on the company's records as on the record date will be eligible for the additional shares. A few weeks later, the shares will start trading ex-split on the stock exchanges.

  • How is it different from a bonus?
Earlier I had mentioned that cash reserves form part of the company's assets. Now when these reserves get large, the company may decide to convert it into shares. These shares are then given free of cost to the investors. So when you get a bonus, the number of shares you own increases at no cost to you.
A stock split is somewhat like a bonus in the sense that, when a Rs 10 stock is split into two Rs 5 shares, the number of shares you hold doubles at no cost to you. But that is where the similarity ends. A bonus is a free additional share. A stock split is the same share split into two.In a stock split, the number of shares increases but the face value drops (the face value never changes for a bonus shares). So a stock split is just a technical change in the face value of the stock. There is no other change in the company.

  • How does this impact you?
In one way, nothing has changed. It's like cutting an 8-inch pizza into 12 slices from four slices before. But, if you want to buy the shares of a company which are frightfully expensive, you can now buy them for less.
For example, the face value of the shares of Rs 100 will now be Rs 50 (above example). So, if the share was quoting at Rs 200 (when face value was Rs 100), it will now quote at Rs 100 (since the face value is now Rs 50).So, those who could not afford to buy the shares at Rs 200, may now be able to buy it at Rs 100. But this is just in theory. Chances are that instead of the stock quoting at Rs 100, it may quote at Rs 120. Sometimes, the stock price of a company goes up after a stock split because demand for those shares increase. More investors may want that stock since they can afford it. For instance, JB Chemicals & Pharma split the face vaue of its stock from Rs 10 to Rs 2, by a four for one split April 5. So for every one stock you held, investors got four new ones. What happened to the price of the stock? It was Rs 451 before the split and adjusted to Rs 90 after the split. The stock did go up, however, from around the Rs 400 level to Rs 451 before the split. Balrampur Chini's split the face value of its stock from Rs 10 to Rs 1 on March 23, sending its stock down from Rs 681 before the split to Rs 68 after it. The stock had moved up from Rs 637 to Rs 668 in the month before the split.The Gammon India stock split on March 15 led to the face value of the stock going down from Rs 10 to Rs 2. The stock was Rs 1,235 before the split, coming down to Rs 247 afterwards. It had moved up from around the Rs 870 level to Rs 1,235 a month before the split.
So do note, if you are an investor in the company, you have reason to celebrate when you get a bonus. No reason to celebrate when your stock is split.
But, if you want to buy more shares, then it is good news because now you will be able to afford them or at least get them cheaper.

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