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Stock split

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Stock split

  1. 1. IMPACT OF STOCKSPLIT ON MARKETPRICES OF SHARES Amity Business School Submitted By:Kaustubh Gupta (E31) Vibhor Pahwa (E33) Jasdeep Kohli (E34) Palash Verma (E35) Mohit Garg (E36)
  2. 2. Introduction& Overview:In todays financial markets, the distinction between stocks and shares has beensomewhat blurred. Generally, these words are used interchangeably to refer tothe pieces of paper that denote ownership in a particular company, called stockcertificates. However, the difference between the two words comes from thecontext in which they are used.For example, "stock" is a general term used to describe the ownershipcertificates of any company, in general, and "shares" refers to a the ownershipcertificates of a particular company. So, if investors say they own stocks, theyare generally referring to their overall ownership in one or more companies.Technically, if someone says that they own shares - the question then becomes -shares in what company?Bottom line, stocks and shares are the same thing. The minor distinctionbetween stocks and shares is usually overlooked, and it has more to do withsyntax than financial or legal accuracy.A stock split or stock divide increases the number of shares in a publiccompany. The price is adjusted such that the before and after marketcapitalization of the company remains the same and dilution does notoccur. Options and warrants are included.Take, for example, a company with 100 shares of stock priced at $50 per share.The market capitalization is 100 × $50, or $5000. The company splits its stock2-for-1. There are now 200 shares of stock and each shareholder holds twice asmany shares. The price of each share is adjusted to $25. The marketcapitalization is 200 × $25 = $5000, the same as before the split.Ratios of 2-for-1, 3-for-1, and 3-for-2 splits are the most common, but any ratiois possible. Splits of 4-for-3, 5-for-2, and 5-for-4 are used, though lessfrequently. Investors will sometimes receive cash payments in lieu of fractionalshares.
  3. 3. It is often claimed that stock splits, in and of themselves, lead to higher stockprices; research, however, does not bear this out. What is true is that stock splitsare usually initiated after a large run up in share price. Momentuminvesting would suggest that such a trend would continue regardless of the stocksplit. In any case, stock splits do increase the liquidity of a stock; there are morebuyers and sellers for 10 shares at $10 than 1 share at $100. Some companieshave the opposite strategy: by refusing to split the stock and keeping the pricehigh, they reduce trading volume. Berkshire Hathaway is a notable example ofthis.Other effects could be psychological. If many investors believe that a stock splitwill result in an increased share price and purchase the stock the share price willtend to increase. Others contend that the management of a company, byinitiating a stock split, is implicitly signalling its confidence in the futureprospects of the company.In a market where there is a high minimum number of shares, or a penalty fortrading in so-called odd lots (a non-multiple of some arbitrary number ofshares), a reduced share price may attract more attention from small investors.Small investors such as these, however, will have negligible impact on theoverall price.
  4. 4. What is a stock split?A stock split is an action by which a company lowers the face value of itsstocks, simultaneously increasing the number of outstanding shares, but keepingthe companys total capital base intact. Suppose that the face value of an XYZcompanys share is Rs 10 and the outstanding shares that have been issued are10,000.If XYZ declares a 2:1 stock split, it means that its shareholders will own twoshares for every one held by them previously, but at half the face value. So thecompanys outstanding shares will double to 20,000, while the face value pershare will halve to Rs 5.So if you owned 50 shares worth Rs 500 before the split, you will now have 100shares worth Rs 500 after the split. This split ratio may vary for differentcompanies. So while one may go for a 3:1 split, another company may opt for a5:1 or 4:3 split. The day that the split is carried out is known as the record date.Only those shareholders whose names appear on the companys records on thisdate are eligible for the additional shares. Subsequently, the shares start tradingat the new price on the stock exchanges.Why is this done?As is obvious from the above example, the split does not affect the value ofyour holdings. It is similar to splitting a Rs 10 note into two notes of Rs 5 each.Similarly, the companys fundamentals dont change, with its earnings andequity capital base remaining the same.So why does the company go for a stock split? It does so in order to make theshares more affordable for a larger group of investors and, thereby, stimulateenhanced trading in the scrip. A stock split is a play on the psyche of theinvestor. When a shares price runs up too high, smaller investors find it difficultto buy it. To make it attractive for such people, the company carries out thesplit, which brings down the share price. So, while some investors may beunwilling to pay Rs 1,000 for a certain stock, they may be more inclined to buyit at Rs 250, following a 4:1 split.Such a move is thus initiated when there is a huge spike in the share price.When shares are trading at abnormal prices, it also affects the scrips trading
  5. 5. volumes on the exchange. By splitting the shares and increasing the outstandingshares available for trading, the company can ensure better liquidity.Can you benefit from this move?Does a stock split affect you? Some investors believe that such a move has noimpact as it is a mere accounting procedure and that it doesnt affect the sharesintrinsic value. This is true at the exact moment that the stock is split, but theprice movement it triggers before and after the split date (even theannouncement date) can interest investors. The most widely accepted view isthat a stock split results in a spike in the share price as the demand for the sharesincreases after the move. There is enough evidence to prove that trading activityusually improves after a split (see table).We considered eight Nifty stocks that have witnessed a split in the past threeyears. Take Bharti Airtel, which split the face value of its stock from Rs 10 toRs 5 in a 2:1 split on 24 July 2009.This sent its stock price spiralling from around Rs 800 before the split to Rs 400after the move. This made a sizeable impact on the scrips volume on the NSE,with average daily traded volume rising 153% in the month after the split,compared with that in the previous month. Consequently, the average dailyturnover rose 26%, while the average trades per day rose by 58%. But whatabout its share price? On the day of the split, it surged by 3.2%, while theSensex rose by 1.2%.This means that the stock value, instead of falling by half, actually fell by alesser amount as more investors bought the stock at the cheaper price. In fact, ascan be seen from the table, this has been true in all but one instance; the stockhas outperformed the broader index by an average 2.1% on the split date itself."Although stock splits seem to be purely cosmetic measures, there exists ampleempirical evidence that these are associated with abnormal returns on both theannouncement and the execution days, bringing a change in the shareholdersholding value," state Bangalore-based professors Suresha B and Gajendra Naiduin a May 2011 report published in the International Journal of Research inCommerce and Management.
  6. 6. Stock split march 2013: Price Price(Sorted by Ex-Date) # Month An- Pay An- Ex- Prior Ticker Split prior Prior To Date Date Date Date To An-COMPANY splits An- Price Price Date Date FEB MARTRIMBLE TRMB° 2:1 2 62.08 59.58 60.71 ? 11 21FRANKLIN FEB MAR FELE° 2:1 2 64.52 64.13 65.55 ?ELECTRIC CO., INC. 22 19JARDEN FEB MAR JAH° 3:2 3 54.45 59.70 58.96 ?CORPORATION 14 19The following are the most recent stocksplit announcements:March 7:Colgate-Palmolive Co. (NYSE:CL) announced today that its board of directorsapproved a 2:1 stock split to be distributed on May 15, 2013.February 22:Franklin Electric Co., Inc. (Nasdaq:FELE) announced today that its board of directorsapproved a 2:1 stock split to be distributed on or about March 18, 2013.February 14:Jarden Corporation (NYSE:JAH) announced today that its board of directors approveda 3:2 stock split to be distributed on or about March 18, 2013.February 11:
  7. 7. Trimble (Nasdaq:TRMB) announced today that its board of directors approved a 2:1stock split to be distributed on or about March 20, 2013.February 5:3D Systems Corporation (NYSE:DDD) announced today that its board of directorsapproved a 3:2 stock split to be distributed on February 22, 2013.Conclusion A stock split is essentially when a company increases the number of shares. Forexample, if you owned 25 shares of XYZ at $15 per share, and there was a 2-1stock split, you would then own 50 shares worth $7.50 each. Why do companiesissue splits if you still have the same amount of money?Liquidity is the major reason. Some companies believe that their stock shouldbe inexpensive so more people can buy it. This creates a condition where moreof the companys stock is bought and sold (this is called "increased liquidity").The problem, in theory, is that the increased activity will also leads to biggergains and drops in the stock, making it more volatile.Many investors believe splits are a good thing. Their thinking goes "Well, if thestock was at $15, and now its at $7.50, it has to go back up to where it was!”This is wrong. The stock is where it was, each share now represents half of theequity in the company that it did before the split. That means that each share isentitled to half the dividend, half the earnings, and half of the assets that it oncewas.A few corporations have been famous for their no-split policies. TheWashington Post has traded well into the $600 per share range, and BerkshireHathaway, which was at $8 a share in the 1960s, has traded as high as$150,000.A stock split is usually done by companies that have seen their share priceincrease to levels that are either too high or are beyond the price levels of
  8. 8. similar companies in their sector. The primary motive is to make shares seemmore affordable to small investors even though the underlying value of thecompany has not changed.A stock split can also result in a stock price increase following the decreaseimmediately after the split. Since many small investors think the stock is nowmore affordable and buy the stock, they end up boosting demand and drive upprices. Another reason for the price increase is that a stock split provides asignal to the market that the companys share price has been increasing andpeople assume this growth will continue in the future, and again, lift demandand prices.Another version of a stock split is the‘reverse split’. This procedure is typicallyused by companies with low share prices that would like to increase these pricesto either gain more respectability in the market or to prevent the company frombeing delisted (many stock exchanges will delist stocks if they fall below acertain price per share). For example, in a reverse 5-for-1 split, 10 millionoutstanding shares at 50 cents each would now become two million sharesoutstanding at $2.50 per share. In both cases, the company is worth $5 million.The bottom line is a stock split is used primarily by companies that have seentheir share prices increase substantially and although the number of outstandingshares increases and price per share decreases, the market capitalization (and thevalue of the company) does not change.As a result, stock splits help make shares more affordable to small investors andprovidegreater marketability and liquidity in the market.