Wednesday, February 27, 2008

Stock splits make stock more affordable and liquid for retail investors

Stock splits make stock more affordable and liquid for retail investors

Prerna Katiyar, TNN

Monday morning, when Mr Gupta opened his demat account to check his stocks, he was taken aback. “What has happened to my shares? How can it fall to this level? I bought the share at Rs 1,000 and it is now trading at Rs 240! Has the whole market crashed today or is it just my stock?” he wondered.

This had happened because the company has announced a 4-for-1 stock split and extra shares were still to be delivered in his account. Poor Mr Gupta, who had missed the company announcement, kept thinking he had incurred heavy losses. So let’s make the case easier for him and find the devil in the detail.

What is a stock split?

Stock split is the process of splitting shares with high face value into shares of a lower face value. It is like getting Rs 100 note changed for two Rs 50 notes. Does it change the value of your money? Not really. But now, you also have two smaller denomination notes which would be easily accepted by small vendors. A stock split increases the number of shares in a public company. The price is so adjusted such that the market capitalisation of the company almost remains the same.

Why split stocks?

Companies usually split their stock when they think the price of their stock exceeds the amount smaller investors would be willing to pay. “It is aimed at making the stock more affordable and liquid from retail investors’ point of view,” said Indiabulls CEO Gagan Banga. Generally, there are more buyers and sellers of shares trading at Rs 100 than say, Rs 400 as retail shareholders may find low-price stocks to be better bargains. Stock splits are usually initiated after a huge run-up in the share. This run-up may be linked to the performance of the stock.

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