Why Companies Choose to Split Their Shares and What It Means
In recent years, the split of shares has become a popular strategy among companies worldwide, including those listed on Indian stock exchanges. A stock split is essentially a corporate action that increases the number of shares in a company by issuing more shares to existing shareholders. Despite the increase in the number of shares, the total value of the shares remains unchanged as the price adjusts accordingly. This article examines why companies opt for the split of shares, what it signifies for investors, and provides insights on how to buy shares in the Indian market.
Understanding Split of Shares
A split of shares are a financial manoeuvre by a company to make its stock more affordable to investors without affecting the underlying market capitalisation. Share splits occur in various ratios, such as 2-for-1, 3-for-1, or even 10-for-1. For instance, if you own 10 shares priced at INR 1,000 each, and the company declares a 2-for-1 split, you will own 20 shares priced at INR 500 each.
Reasons for Stock Splits
Increased Liquidity
With a reduced price per share, newer investors find it easier to purchase shares, thus increasing the liquidity of the stock. Liquidity is crucial as it indicates how easily assets can be converted into cash without affecting the price. A liquid stock generally attracts more market activity, thereby creating a vibrant trading environment.
Higher Demand
As the price of individual shares falls due to the split, more investors can afford to buy them, magnifying demand. Increased demand can often lead to a rise in share prices, generating growth for the company long-term.
Managerial Psychology
Companies sometimes split shares to signal confidence in their future prospects. When a company frequently splits its shares, it may be sending a message that it expects continued growth.
Accessibility
Stock splits can make high-priced stocks more accessible to retail investors. For example, an INR 2,000 stock may become an INR 200 stock following a 10-for-1 split, enabling cost-sensitive investors to participate in the market.
What Does a Stock Split Mean for Investors?
Investors often view stock splits as a sign that a company is doing well. While a split doesn’t directly impact the valuation fundamentals of a company, it can indirectly contribute to a rise in price due to psychological factors. Nonetheless, it’s noteworthy that splits do not modify the intrinsic value of shares. Consideration of broader market conditions, company fundamentals, and future performances remains pertinent.
How to Buy Split of Shares
Before buying shares, especially of a company declaring a split, investors need to evaluate specific aspects of the stock and the prevalent market conditions. Here’s a concise guide on how to buy shares in India:
Open a Demat and Trading Account
To trade on Indian stock exchanges, you must have a Demat account for holding securities electronically and a trading account for transaction purposes. Popular brokerage firms offering these services comply with regulations and are members of SEBI (Securities and Exchange Board of India).
Research Stocks
Conduct thorough research on the performance, management, growth potential, and valuation of a company before purchasing shares. Tools such as financial statements, market trends, and analyst reports may aid in informed decision-making.
Example Calculation
Assume a company with an EPS (Earnings Per Share) of INR 50. If the share price is INR 1,000, the P/E ratio is calculated as:
P/E Ratio = Share Price ÷ EPS
P/E Ratio = 1,000 ÷ 50 = 20
Comparing P/E ratios across companies in the same sector can provide insights into whether shares are overvalued or undervalued.
Place Orders
Using your trading account, place buy orders for stocks. Limit orders and market orders are widely used.
Monitor Your Investments
Keep a close watch on your holdings, especially with fluctuations arising from corporate actions such as stock splits. Reacting to market updates judiciously can further your investment strategy.
Handling Calculations Post Split
For investors, calculating their holdings post-stock splits is crucial to understand the dynamics of investment.
Suppose you own 100 shares of a company, each priced at INR 500. After a stock split of 2-for-1:
New Number of Shares = 100 × 2 = 200
New Price per Share = 500 ÷ 2 = INR 250
Calculations to assess holdings post-split are vital for maintaining informed control over one’s portfolio.
The Impact on Market Perception
While stock splits can engender optimism, it’s imperative to remember that splits are merely a mathematical realignment of share quantity and price. Market reaction is contingent on investor sentiment, perceptions, and prevailing economic conditions.
Disclaimer
Stock trading involves substantial risk, and investors should duly gauge all pros and cons of trading in Indian stock markets. This article aims to provide general understanding and should not serve as specific investment advice. Engaging with financial experts or counsellors is advisable when seeking tailored guidance.
Conclusion
The split of shares is a trending strategy among companies to facilitate accessibility and liquidity without altering the underlying value. As an investor, understanding the intricacies of stock splits, and being informed about how to buy shares, safeguards against impulsive decisions and contributes to an informed investment approach.
