Stock or Share Split

[Submitted by CA. Vibhuti Gupta,
Chartered Accountant,
New Delhi]

May 5, 2010

Stock Split : It increases the number of equity shares in a public company. The price of shares is adjusted in such a way that the market capitalization of the company will remain the same after the split, so that dilution does not occur. Options and warrants are included. A stock split is a decision by the company's board of directors to increase the number of shares that are outstanding by issuing more shares to current shareholders

In other words : A stock split is a corporate action that increases the number of the corporation's outstanding shares by dividing each share, which in turn diminishes its price. The stock's market capitalization, however, remains the same, just like the value of the Rs 100 note does not change if it is exchanged for two Rs 50s. For example, with a 2-for-1 stock split, each stockholder receives an additional share for each share held, but the value of each share is reduced by half: two shares now equal the original value of one share before the split.

An example to explain stock split: Stock A is trading at Rs 400/stock and has 10 million shares issued, which gives it a market capitalization of Rs 4000 million (Rs 400 x 10 million shares). The company then decides to implement a 2-for-1 stock split. For each share shareholders currently own, they receive one share, deposited directly into their brokerage account. They now have two shares for each one previously held, but the price of the stock is split by 50%, from Rs 400 to Rs 200. Hence, the market capitalization stays the same - it has doubled the amount of stocks outstanding to 20 million while simultaneously reducing the stock price by 50% to Rs 200 for a capitalization of Rs 4000 million. The true value of the company hasn't changed one bit.

The most common stock splits are, 2-for-1, 3-for-2 and 3-for-1. An easy way to determine the new stock price is to divide the previous stock price by the split ratio. In the case of our example, divide Rs 400 by 2 and we get the new trading price of Rs 200. If a stock were to split 3-for-2, we'd do the same thing: 400/(3/2) = 400/1.5 = Rs 266.67.

A stock's price is also affected by a stock split. After a split, the stock price will be reduced since the number of shares outstanding has increased. In the example of a 2-for-1 split, the share price will be halved. Thus, although the number of outstanding shares and the stock price change, the market capitalization remains constant.

A stock split is usually done by companies that have seen their share price increase to levels that are either too high or are beyond the price levels of similar companies in their sector. The primary motive is to make shares seem more affordable to small investors even though the underlying value of the company has not changed.

A stock split can also result in a stock price increase following the decrease immediately after the split. Since many small investors think the stock is now more affordable and buy the stock, they end up boosting demand and drive up prices. Another reason for the price increase is that a stock split provides a signal to the market that the company's share price has been increasing and people assume this growth will continue in the future, and again, lift demand and prices.

Another version of a stock split is the reverse split. This procedure is typically used by companies with low share prices that would like to increase these prices to either gain more respectability in the market or to prevent the company from being delisted (many stock exchanges will delist stocks if they fall below a certain price per share). For example, in a reverse 5-for-1 split, 10 million outstanding shares at Rs 400 each would now become two million shares outstanding at Rs 2000 per share. In both cases, i.e., stock split & reverse stock split, the company is worth Rs 4000 million.

Different types of stock splits

Forward stock split: When any company will announce a forward stock split, the price of the stock will decrease; however, the number of shares will increase proportionately. For example, if you own 100 shares of XYZ Company that operates at Rs100/share, and it announces a two for one stock split, you will own a total of 200 shares at Rs 50.00 after the split. Although many stock splits are two for one, companies can split their stock in any number of ways, including three for one, three for two, and so forth. The stock market average returns for these new shares will reflect the ratio that was used in the split.

Advantages of Forward Stock Splits : The most important reason for a company to use this stock market strategy is to increase liquidity of the stock. Although there are investors buying certain companies stock at over Rs 100 per share, many more investors would be inclined to buy if there were five times more shares at Rs 50 per share. This tactic is employed by many companies when their stock sales come to a standstill because of the consistent increase in the prices of their stocks.

Reverse stock split: Reverse stock splits are less likely to be used by the companies as they show somewhat of a negative investment strategy attached to them. The reverse stock split is defined as the stock split under which a firm’s number of shares outstanding is reduced. If the price of a stock for a certain company drops too low, many mutual funds will not purchase them. Therefore, by having the low prices for their stocks, they run the risk of being delisted, or even being removed from the market indexes. In addition, the low stock prices of a company would create a psychological stigma as buyers and sellers view them as worthless. By doing a reverse stock split, companies can raise the stock price by lowering the number of outstanding shares; therefore, eliminating the problems caused by the low stock prices.

Advantages of Reverse Stock Split: There are three reasons why a company would want to go for a reverse stock split. First of all, the transaction costs to the shareholders would be less after the reverse stock split. Secondly, the liquidity and marketability of a company’s stock might be improved when its price is raised to the popular trading range. Finally, a stock selling at certain price below a certain level are not considered respectable which means that the investors underestimate these companies earnings, cash flow, growth, and stability. A reverse stock splits reduces the number of shares and increases the share price proportionately. For example, if you own 10,000 shares of a company and it declares a one for ten reverse split, you will own a total of 1,000 after the split. A reverse split has no affect on the value of what shareholders own.

Eligibility for stock split: Trading in the equity shares of the company should be in Compulsory Demat

Documents to be submitted prior to Corporate Action :

* Companies on whose stocks derivatives are available or whose stocks form part of an index on which derivatives are available at the time of fixing Book Closure/ Record Date, should give advance notice of at least thirty days while fixing Book Closure/ Record Date the company.

Documents to be submitted post Corporate Action

Suggestive Format
 

1. Intimation of Record Date / Book Closure

2. Details of Issued and Paid up Capital

3. Undertaking from the Companies (on Company’s Letterhead)

The Board of Directors of the Company has fixed a record date of DD/MM/YYYY for the purpose of sub-division / stock split of Rs. /- per share of the company into shares of Rs. /- each.

We hereby undertake that all the beneficiaries will be credited with the split / sub divided shares in their respective demat accounts within one day from record date fixed for sub-division / stock split i.e. DD/MM/YYYY.

Accounting aspects of Stock Split

• A Stock Split has NO effect on total:
  
  • contributed capital
  • retained earnings
  • total stockholders' equity
     
• Reasons why no accounting treatment is prescribed for stock splits.
  
  1. Because the total par value of shares outstanding is not affected by a stock split (i.e., the number of shares times par value per share does not change)
      
  2. The share price would fully adjust to reflect the additional shares.
      
  3. It does not provide any dividend income to shareholders

Hence, only a memorandum notation in the accounting records indicates the decreased par value and increased number of shares.

Example for stock split: A stock split occurs when a Board of Directors authorizes a change in the par or stated value of its stock. This reduction in par value is made to lower the market price of the stock to make the stock more attractive to potential investors. When a company's stock splits, the change in the par value is offset by a corresponding change in the number of shares so the total par value remains the same. The total stockholders' equity is unaffected by the stock split and no entries are recorded. For example, if ABC Limited declared a 3-for-1 stock split , the company would issue three shares in place of every one share currently held. After the split occurs, the par value or stated value is divided by 3 (because it is a 3-for-1 stock split) to determine the new par or stated value, and the number of outstanding shares is multiplied by 3. After the stock split, the new par value is Rs100 (Rs 300 ÷ 3) and the number of outstanding shares is 150,000,000 (500,000 × 300). The total par value of the common stock remains at Rs 150,000,000 (1,500,000 shares × Rs 100 par value). The following chart illustrates the effects of stock dividends and stock splits on stockholders' equity :

STOCK SPLIT EFFECT ON STOCK'S PRICE

Impact on current stock holders : It means that the stock holder now has more shares in the company, but each share is priced less. Their overall value of stocks stays the same, though the price of stocks is generally affected by a stock split, and so there is a good chance the value of their stock will go up because of the stock split.

Effect on stock split on stock’s price: No & Yes –
No because : When the stock splits, the value of the stock as a whole stays the same. So, no the stock price is not effected. A stock holder still holds just as much value of stock as they did before. For example, while before a stock split an investor has 100 shares of stock at Rs 400/share, so they have Rs 40000 worth of stock. After the split they have 200 shares of stock at Rs 200/share, so they still have Rs 40000 worth of stock.

Yes because : As the price of a stock gets higher and higher, the stock becomes unaffordable for small investors, and thus they do not buy it, so the solution is to make the price per share less, but the value of each share less as well. Splitting the stock brings the share price down to a more "attractive" level, but the ownership in the company remains the same, there is just more stock to divide between. So, while the price changes, the value does not. However, the lower stock price may affect the way the stock is perceived and therefore entice new investors. So, as the stock becomes more affordable, more people buy it, and then the price goes up. Thus, the answer is yes because often as a result of splitting stocks, prices will rise.

The thing to remember with stock splits is that while the price and number of shares may change, the overall value of the stock stays the same.

The following are the most recent stock split announcements:

May 3, 2010:

General Mills, Inc. (NYSE:GIS) announced today that its board of directors approved a 2:1 stock split to be distributed beginning June 8, 2010.

Industrial Services of America, Inc. (Nasdaq:IDSA) announced today that its board of directors approved a 3:2 stock split to be payable on May 31, 2010.

April 29, 2010:

Baidu, Inc. (Nasdaq:BIDU) announced today that its board of directors approved a 10:1 stock split to be payable on May 11, 2010.

April 28, 2010:

TESSCO Technologies, Inc. (Nasdaq:TESS) announced today that its board of directors approved a 3:2 stock split to be distributed on May 26, 2010.

Green Mountain Coffee Roasters, Inc. (Nasdaq:GMCR) announced today that its board of directors approved a 3:1 stock split to be distributed on May 17, 2010.

April 12, 2010:

Edwards Lifesciences Corp. (NYSE:EW) announced today that its board of directors approved a 2:1 stock split to be distributed on May 27, 2010.

April 7, 2010:

BioReference Laboratories, Inc. (Nasdaq:BRLI) announced today that its board of directors approved a 2:1 stock split to be distributed on or about April 21, 2010.

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