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Why companies carry out stock splits

Ugodre Obi-Chukwuu

Last week, we discussed share reconstructions. This week, we will be looking at its exact opposite called the stock split. A stock split is a process whereby a company splits a unit of its shares to make it more available and affordable.

Example: A company has 500,000 units @N4 per share now decides to have two shares for every one share held. This is stock split of its shares.

Previously – 500,000 units of shares @ N4 each

Stock split of two for one

Now – one million units of shares @N2 each.

Despite the fact that the value of the company theoretically remains the same, companies still embark on stock splits for a number of reasons.

We will use the following illustration to help explain. Two companies A and B have the same market value of N10m per share. However company A has a share price of N100, 000 per share and therefore only has 100 ordinary shares outstanding. Company B on the other hand is priced at N1 per share and has 10 million ordinary shares outstanding

Makes the share price more affordable

While both companies above still have the same market value of N10m, company A is less affordable than company B. To understand how this can affect you, imagine you only have N100, 000 to invest in the stock market and wish to spread the investment among various portfolios of stocks. You will only be able to buy shares in company A because a share in the company cost N100, 000 which basically is all of the money you have available to invest. The only option you will have is to avoid the stock of company A completely or invest in a mutual fund that has company A in its portfolio. Contrast this to company B in which by splashing just N20, 000, you will own 20,000 shares in the company as against one in company A. Remember, the value is the same for an investor with one share in company A and the investor with 100,000 shares of company B. The only difference is that company B allows you to spend some of your money investing in it while for company A, it means you probably have to spend all you have.

Makes the shares more available

As in the example above, company A has only 100 ordinary shares available compared to company B with 10 million ordinary shares. Company B is therefore more liquid than company A as more people have the opportunity to own shares in the former.

Meeting listing requirements

Some stock exchanges, like the Nigerian Stock Exchange requires as part of its listing requirements, a sizeable number of shares of any company to be available for trading before been listed. Based on this, most companies in their desire to meet listing requirements in exchanges often embark on share splits to increase the number of shares available. Company A for example, may not pass the listing requirements for the NSE.

 How does stock split affect shareholders?

For a shareholder, stock splits will result in no change to the ownership structure of a company. Even though they have more shares, the increase is proportionally distributed. However, this may or may not translate to increase in value. For example, a stock split may translate to increase in value due to the increased availability and affordability of the stock. The resultant increase in demand can help push up prices and ultimately the value of the company.

Conversely, investors may also view stock split in a negative light. The increase in liquidity of the stock may soon make it so tradable and attractive to bears. Because it is now available in tradable quantities, a situation where you have more sellers (bears) than buyers may affect the share price negatively.

Stock splits may also result in huge cost to the company as they now have more shares available for the registrars to manage. This cost is typically passed on to the shareholders as it reduces profitability.

 What you must do after a stock split

As a shareholder of a company which has just concluded a stock split, you must give your stockbroker a call or pay them a visit to get a full understanding of its implication on your shares. Once you understand it, you must then ensure you get the full compliments of your new shareholdings and make sure it is proportionally equal to what it was pre-stock split.

I have shares in a company but have never bothered about stock split

Not all companies embark on stock splits, however you can independently find out if a stock split had been carried out in the past. Historical, shareholding structure of companies can be found in every annual report released by companies. If it contains information about a stock split that you are unaware of, then you must seek the advice of your stockbroker to regularise your holdings.

Do I get share certificate for stock split?

After a stock split has been concluded, you are given new share certificates representing the new shares. However, you may also be  given back the shares electronically with the Central Security Clearing System.

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