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Things to know about Stock Splits

First of all, lets talk about what a stock split is. In general, a stock split is the division of a share into multiple shares with lower face value. The splitting takes place in such a way that the total market cap after the splitting stays the same. Evidently, this means that the total holding you have in the day of splitting doesn’t change when the number of shares increase.

Normally after a split, new investors tend to buy the stock with lower price, hoping to gain. Well, this is not a right approach for split stocks. Because, there is an absolute chance that after the split, half or more stock could drop its price. Consequently resulting in loss. Lets discuss the right strategies for stock splits later in this article.

WHY DO COMPANIES GO FOR STOCK SPLITS?

The main objective of stock splits is to increase liquidity. As liquidity increases, its makes the stock more affordable. As a result, more investors trade the stock and it helps in identifying its true value.

Lets see an example of how stock splits work. Consider a firm with some outstanding shares of face value ₹20. Then, undergoes a split of ₹4 face value per share. Therefore, 1 share of ₹20 becomes 5 shares of ₹4 face value. Accordingly, a trader with 200 shares of the firm will own 1000 shares after the split.

IMPACT OF STOCK SPLITS IN INVESTORS

If you have a stock that undergoes split, the number of shares you have will certainly increase. However, as market cap stays the same, price per share decreases. As a split reduces the face value, more investors would buy the shares at a lower price. It doesn’t seem like the stock split automatically brings benefits to those who bought the shares at a lower price. A reason for this could be that the market gets a signal from the split if the company’s share price has been increasing before the split. This consequently gives the investors an idea that the growth might continue.

Although, a company’s fundamentals should be analyzed while going for a split stock. The performance of a share always depends on the market condition and the fundamentals of the company.

Now, lets analyze the stock performance of ITC and Bharti Airtel.

ITC shares had a split ratio of 1:10 and the share price rushed 33.45% to ₹93.50 after the split. This happened during 2005 Sep 21 to 2006 Sep 20. During April-Sep 2005, before the split, the average trading volume of the company shares was at 1.04 lakh against 24.89 lakh shares. On 2005 June quarter, ITC announced a net profit of ₹558.30 crore, up 20.85%, against ₹461.99 crore.

Bharti Airtel had a split ratio of 1:2 and the share price moved around 25% from ₹415.50 to ₹313.70. This happened during 2009 July 4 to 2010 July 23. During January 1-July 23, 2009, the average trading volume stayed at 6.90 lakh against 20.13 lakh shares. On 2009 June quarter, the company announced a net profit of ₹2,687.50 crore, up 31.30%, against ₹2,046.79 crore.

CONCLUSION

After the split, stocks can go in any direction. Splits always have a neutral effect on the price performance of the stock. Therefore, you should always check the fundamentals of the company before investing in it.

 

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