Recently MRF hit a high of Rs. 50,000 and people said “OMG this share has reached Rs. 50,000”. Obviously these people do not know that on Berkshire Hathway share has reached a price of US $ 217,000 – well you can buy a couple of nice villas for that price!
Take another company Lakshmi Machine Works – it has two bonuses once in 1989 and one in 1997 and it did a stock split. Lets ignore the first stock split of 1989, and just consider the bonus of 1:1 of 1997. Which means I would have had half the number of shares. Wait there was a split from a Rs. 100 share to a Rs. 10 share in 2006..so my ‘number of shares’ went up by 10 times.
Assuming I had 200 shares in 1995..it became 400 in 1997. Good…then it became 4000 in 2006. The price per share is now about Rs. 4500…so that becomes Rs. 1.8 crores.
What would have happened if there was no stock split or no bonus? I guess it would be something like this – the value would have probably been the same..Rs. 1.8 crores and each share would be worth Rs. 90,000 per share. Not bad. Almost double the price of MRF.
In a typical “two-for-one” split, a company doubles the number of its shares outstanding while halving the per-share price. Suppose it is a share that you have 200 nos. and it is valued at Rs. 450. Suddenly you will find that you have 400 shares and each share is now worth 225. The value remains the same….Rs. 90,000. You end up holding twice as many units each worth half its former price. You’d be foolish to think that makes you richer. Long ago when shares were traded manually and accounting was done much later, we needed to have ‘regular lots’ of 10 or 100 and others were considered odd lots. Also if the buyer is an individual who looks at ‘price’ as in individual share price, splits and bonuses made sense.
Similarly if you had 1000 shares of 100 face value..and there is a stock split you will have 10,000 shares of Rs. 10 each. That is all. You suddenly realize the difference between value and price. The value cannot change just because there is a split – yes price changes.
So today when we have more institutional trading and investing, decisions driven by PE and not just by price alone, we do not need splits or bonuses. However, in India you can expect to see more splits, bonuses, and buy backs of course. This is because of the dividend tax that is likely to hurt the promoter – so the rewards will be in the form of bonus, stock split..and buy back of the same. Tax arbitrage……
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