Introduction

Stock splits, including upcoming stock splits, are a common strategy employed by companies to make their shares more accessible and attractive to investors. While this corporate action can offer numerous benefits, it is not without its drawbacks. Understanding the advantages and disadvantages of stock splits, especially within the Indian market, helps investors make informed decisions and assess potential impacts on their portfolios. This blog will explore the concept of stock split, delve into their pros and cons, and provide real-life Indian examples for better insight.

What is a Stock Split?

A stock split is a corporate action in which a company increases the number of its outstanding shares by issuing more shares to existing shareholders. This action lowers the stock price proportionately but does not affect the company’s market capitalisation.

Example: If a company’s share is trading at ₹1,000 and it announces a 2-for-1 stock split, each shareholder will receive an additional share for every one they own. The company will adjust the new share price to ₹500, doubling the number of shares while maintaining the total investment value.

Types of Stock Splits

• Forward Stock Split: The most common type increases the number of shares and reduces the price per share proportionately.
• Reverse Stock Split: A less common type where the number of shares is decreased, and the price per share is increased. Companies may use this to maintain listing requirements or signal strength in the market.

Benefits of Stock Split

1. Increased Liquidity: One of the primary advantages of stock split is improved liquidity. More shares in the market typically lead to higher trading volumes, making it easier for investors to buy and sell shares.
2. Affordability for Retail Investors: By reducing the price per share, stock splits make shares more accessible to retail investors, encouraging broader participation.
3. Enhanced Market Perception: A lower share price can create the perception that the stock is more affordable, potentially attracting more buyers.
4. Stock Split Calculator Utility: Investors can use a stock split calculator to predict the outcome of a split on their holdings, enabling them to make well-informed decisions.

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Real-Life Examples of Stock Splits in India

Several high-profile companies in India have leveraged stock splits to make their shares more attractive:

• Tata Consultancy Services (TCS): TCS announced a 1:1 stock split in 2018, which led to a surge in trading volume and made the stock more accessible to retail investors. This move was aimed at maintaining investor interest and supporting long-term liquidity in the market. The split doubled the number of shares in circulation, resulting in increased participation from a broader range of investors and boosting market activity.
• Reliance Industries: In 2017, Reliance conducted a 1:1 stock split, which significantly enhanced affordability and trading activity. By halving the share price, the company enabled more investors to buy shares, leading to increased liquidity and stronger market engagement. This strategic move reinforced investor confidence and showcased Reliance’s commitment to fostering a more inclusive investment environment.
• Avenue Supermarts (DMart): Avenue Supermarts executed a stock split in 2019, reducing its share price to attract more retail investors. The split made the shares more affordable, resulting in a noticeable rise in trading volumes and broader market participation. This move helped the company strengthen its shareholder base and enhance market visibility, demonstrating how stock splits can effectively broaden the reach and appeal of a company’s shares.

Advantages of Stock Split

1. Broader Investor Base

One of the main advantages of a stock split is that it attracts a wider range of investors by making the shares more affordable. High stock prices can be prohibitive for small or retail investors who may find it challenging to buy shares at higher values. By splitting the stock and effectively lowering the price per share, more investors can participate in trading the stock. A broader investor base boosts market activity, diversifies the shareholder mix, and encourages individual investors to participate, even those previously priced out.

2. Improved Liquidity

Stock splits often lead to an increase in the number of outstanding shares, which generally results in improved market liquidity. More shares in circulation mean a higher volume of trading, making it easier for investors to buy and sell shares without significantly impacting the stock price. Enhanced liquidity is beneficial not only for the individual investor but also for the overall market, as it supports smoother transactions and can reduce the bid-ask spread. This can contribute to a more efficient and stable market for the company’s stock.

3. Psychological Advantage

A stock split can create a psychological perception among investors that the stock is more affordable or undervalued, even though the underlying fundamentals of the company remain unchanged. For instance, if a stock is trading at ₹2,000 per share and undergoes a 2-for-1 stock split, the price per share will drop to ₹1,000. While the total investment value remains the same, the reduced share price often appeals to investors who perceive it as a better entry point. This can lead to increased demand for the stock, which may drive up its price over time.

4. Positive Market Sentiment

The announcement of a stock split is often viewed as a signal of strong past performance and optimistic future growth. Companies typically opt for a stock split when their share price has risen significantly, indicating solid business growth and investor confidence. This announcement can lead to a positive reaction in the market, boosting investor morale and potentially leading to an increase in the stock price due to heightened interest and activity. Investors perceive a company as confident and poised for continued success when it decides to split its stock.

5. NSE Stock Split

Companies listed on the National Stock Exchange (NSE) in India often conduct stock splits to remain competitive and increase their market appeal. By performing a stock split, these companies make their shares more accessible to a broader range of investors, enhancing their attractiveness in the highly competitive NSE market. This strategic move can boost the company’s visibility, attract more retail investors, and stimulate trading activity, contributing to the stock’s overall performance and the company’s market standing. The increased participation from a diverse group of investors can lead to a stronger and more stable market presence.

Disadvantages of Stock Split

1. No Direct Financial Gain

One of the most significant drawbacks of a stock split is that it does not provide any immediate financial benefit to shareholders. While a stock split increases the number of shares each investor holds, the overall market capitalisation of the company and the value of each individual’s investment remain the same. For example, in a 2-for-1 stock split, a shareholder who owned one share valued at ₹1,000 will now have two shares priced at ₹500 each. The total investment value is still ₹1,000. This means that, unlike dividends or buybacks, stock splits do not provide a direct financial reward to shareholders. Instead, the primary benefit is improved liquidity and accessibility, which may or may not lead to long-term gains.

2. Short-Term Volatility

The announcement of a stock split can sometimes trigger short-term volatility in the stock’s price. This volatility is typically driven by increased trading volume as new investors enter the market, attracted by the lower share price. While this can be positive in terms of liquidity, it can also lead to price swings that may be unsettling for existing shareholders. Such fluctuations can arise from speculative trading as investors try to capitalise on the perceived opportunities presented by the split. For those who prefer stable, long-term investments, this short-term price volatility may be seen as a drawback.

3. Perception of Overvaluation

Frequent stock splits may lead to a perception that the company is trying to create artificial demand for its shares. If a company conducts stock splits too often, it may raise concerns among investors that the stock is becoming overvalued, with the company attempting to maintain an appearance of affordability and high demand. This perception can be problematic, as it might attract short-term traders looking for quick gains rather than long-term investors who contribute to the stock’s stability. The market may interpret frequent splits as the company focusing on boosting its share price rather than sustainable growth, which leads to skepticism about its financial health and long-term strategy.

4. Complexity for Shareholders

Tracking stock holdings after a split can be challenging for some investors, particularly those with diversified portfolios that include shares in multiple companies undergoing splits. The need to adjust for new share quantities and recalibrate investment performance metrics can be confusing, especially for less experienced investors. This added complexity can make it difficult to monitor the value of investments accurately and plan future strategies. For example, calculating the adjusted cost basis for tax purposes becomes more complicated, which can lead to errors or additional effort during tax filing. The more frequent the splits, the more complex portfolio management becomes, potentially deterring some investors from holding the stock.

Forward Stock Split:

The most common type is where the number of shares is increased and the price per share is reduced proportionately. In a forward stock split, shareholders receive additional shares based on the split ratio, making shares more affordable and increasing market participation.

Example: if a company announces a 2-for-1 forward stock split, a shareholder owning 100 shares priced at ₹1,000 each would now own 200 shares priced at ₹500 each. The overall value of their investment remains ₹100,000, but the lower price per share makes it more attractive to a broader range of investors. Companies often use forward stock splits when their stock price has risen significantly, signalling robust performance and anticipated growth.

Reverse Stock Split

While most discussions focus on forward stock splits, it’s essential to understand reverse stock splits. In a reverse stock split, a company consolidates its shares, reducing the number of shares outstanding while increasing the share price.

Example: If a company announces a 1-for-5 reverse stock split, shareholders will receive 1 share for every 5 shares they currently own, increasing the stock price fivefold. Although this may improve the stock’s marketability, it can also indicate that a company is attempting to prop up its share price.

Conclusion

Stock splits, whether forward or reverse, can significantly impact investor participation and market dynamics. While there are notable benefits of stock splits, such as increased liquidity and affordability, they also come with drawbacks like short-term volatility and potential misinterpretations. Understanding the advantages of stock splits and evaluating their long-term implications helps investors make better financial decisions.

For expert guidance, connect with Jainam Broking Ltd. Our team is here to help you navigate stock splits and optimise your investments effectively. Visit our website or contact us today to learn more and optimise your investment strategy.

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