EPS or Earnings per share is one of the most important terms in the finance domain. Especially, if you are an investor or a shareholder, you should special focus on this number and the trend it is following.
Earnings per share (EPS) is the part of a company’s profit which is allocated to each outstanding share of the stock. It is a very useful metric which can help in judging a company’s financial health.
EPS is calculated by taking net income and subtracting the preferred dividends from it. The value obtained has to be divided by the average number of outstanding shares. Preferred dividends are those paid on a company’s preferred stock.
A higher EPS indicates that the company is profitable and is also able to pay money to its shareholders.
Types of EPS
Trailing EPS: It is the most commonly used form of EPS because it represents what happened in the past with certainty. Correctly predicting the future is very difficult. Thus, this form of EPS uses the earnings number of the previous four quarters.
Current EPS: In this, current earnings are taken to calculate EPS. Some quarter of earnings data may have been out already, and some of that is yet to come. Thus, current EPS uses some of the actual data and some of the factual data.
Forward EPS: As the name suggests, EPS calculated in this form takes into the estimates of earnings that may come in the future. Earnings are forecasted by the analyst. Based on these forecasted earnings, forward EPS is calculated.
Calculating Earnings per Share
EPS = net income – preferred dividends / average outstanding common shares
Example : Let Net Income = Rs 10,00,000 and Preferred Dividends = Rs 2,00,000. If Average outstanding common shares = 5,00,000 then, EPS = (10,00,000 – 2,00,000)/5,00,000 = Rs 1.6
Just like liquidity ratios, solvency ratios are a key component when conducting company’s financial analysis. It tells whether the company is capable enough to pay its long-term dues from the cash flow generated.
Long-term liabilities are those debt obligations which are not due to be paid in this year but in the coming years. Both Solvency and liquidity are equally important for a company’s financial health.
Remember, liquidity ratio deals with the short-term debts and solvency ratio deals with the long-term debts. To know more about liquidity ratios, clickhere.
Solvency Ratio Metrics
Debt to equity ratio = Total Debt/ Total Shareholder’s Equity
This is a very commonly used solvency ratio. It is one of the most important metrics when understanding a company’s financial leverage. Debt-to-equity ratio tells how capable a firm is to cover all of its debts with the shareholder’s equity. A value states that the company is using debt for fuelling its growth. Lower D/E ratio is better as it shows higher solvency of the business.
Interest Coverage Ratio = EBIT / interest payments due on debt
EBIT stands for Earnings before interest and tax. This ratio indicates whether the company can pay interest on the outstanding debt obligations. Higher the interest coverage ratio, more stable the company is to pay the interest related to debts from its earnings.
Imagine two companies, company ABC with an Interest coverage ratio of 1.5 and company XYZ with interest coverage ratio 2.5. In this situation, XYZ is considered to be in a better situation to pay the interest payment of its debt obligation when compared to company ABC. When doing financial analysis, it would be better if the company’s solvency ratios are compared to the those of its competitors in the industry.
DVR or differential voting rights shares are like ordinary equity shares but with differential voting rights. Shares can have higher or lower voting rights as compared to ordinary equity shares. Since Indian regulations do not permit companies to issue equity shares with higher voting rights Indian DVR shares provide for lower voting rights as compared to ordinary equity shares.
DVR shares are highly illiquid, they do not trade in high volumes as compared to ordinary shares.
Why would a company issue DVR Shares?
Prevention of a hostile takeover, different from the company’s interest
It also helps strategic investors who do not want control but are looking at a reasonably big investment in a company due to its low price and high dividend.
When Tata Motors had declared its dividend in 2006, it gave the DVR holders a dividend of six per cent and the ordinary shareholders one per cent. For example, the Tata Motors DVR shares were trading at Rs 689.80 on the National Stock Exchange (NSE) and the ordinary ones at Rs 1,255.75 on Wednesday.
A company can raise money from three platforms: 1) Acquiring debt 2) Selling equity 3) Looking at their reserves. A qualified institutional placement (QIP) is one of the ways through which a company raise funds by selling equity.
A company sells its shares by issuing an IPO. In an IPO, retail investors, Non-institutional bidders, Qualified Institutional Bidders (QIB’s) and Anchor Investors bid to acquire shares. QIP is a tool for raisingcapital from the market but only available to Qualified Institutional Bidders.
Who are Qualified Institutional Bidders (QIB’s)?
QIBs are those institutional investors who are considered to have financial knowledge and capability to invest through capital markets. Mutual funds, venture capital fund, Alternative Investment Fund, Provident Funds with minimum corpus of Rs.25 crores, ULIP schemes of insurance companies and pension schemes, all are considered to be in the QIB category.
Why QIP?
Qualified institutional placements follow a relaxed set of regulations when compared to an IPO. It allows an Indian-listed company to raise capital without filing any pre-issue notice to the regulators. Another main reason why SEBI allowed QIPs was that the companies do not over-depend on the foreign capital for the funding.
As QIPs follow a lesser number of rules and regulations, companies save a lot of costs. During IPOs, a company incurs fees in several stages, for example, legal fees. QIP, as a tool, passes on through less number of checks and thus act as a cost-efficient tool to raise money.
Recently in news
Private sector banks, ICICI Bank, Axis Bank and Housing Development Finance Corp Ltd (HDFC), have raised over Rs 30,000 crore from QIPs this year(2020). The ICICI Bank launched its QIP to raise Rs 15,000 crore. They were followed by, Axis Bank stated that their QIP has helped them in raising Rs 10,000 crore. HDFC also procured Rs 14,000 crore of funds via QIP. This shows, that even amidst COVID-19, the investors are backing the banks and are willing to buy their stakes.
Every company has some or other liabilities. These liabilities are short-term and long-term. Short-term liabilities refers to those which are due to pay within 12 months. Long-term liabilities, as understood, refers to those which have to be paid after the running financial year.
Liquidity Ratios gives an idea of how capable a firm is to pay its short-term dues. This financial ratio tells how competent an entity is to pay these obligations with their current assets and without any financial assistance. Higher the liquidity ratio, better for a company.
Liquidity Ratio Metrics
Current Ratio: Current Assets/ Current Liabilities
This ratio indicates a company’s ability to pay off its current liabilities (short-term liabilities) with its current assets. These current assets consist of cash, inventories, marketable securities and accounts receivables.
Quick Ratio: (Current Assets – Inventories)/ Current Liability
As the name suggests, quick ratio involves those current assets that can be easily converted into cash. Inventories are part of current assets but are not the most liquid form of current assets. Inventories may take time to be sold and thus quick ratio does not take inventories into account. Thus, this ratio is also known as “Acid-test ratio.”
Cash Ratio: Cash/Current Liability
Company’s most liquid assets are cash. Cash Ratio indicates the ability of the firm to pay its short-term liabilities with its most liquid form of asset. Generally, investors trust a company more with higher cash ratio. They believe that the company has enough cash to pay them even if the business doesn’t turn out to be profitable.
Example
Imagine a company ABC has following particulars:
Cash
10000
Inventories
5000
Accounts receivables
5000
Current Liabilities
25000
Current Ratio = (10000+5000+5000)/25000 = 0.8 (In Current Ratio, all the current assets are taken.)
Quick Ratio = (20000-5000)/25000 = 0.6 (Inventories are not a part of quick assets, hence it is subtracted from current assets.)
Cash Ratio = 10000/20000 = 0.5 (Cash Ratio considers only cash as the current assets, as it is the most liquid form of assets)
While reading company results we often come across the terms “Consolidated Results” and “Standalone Results”. The big question is, which one should you use to assess a company’s health? Let’s find out what the terms mean.
Consolidated Statement
Consolidatedstatements represent the financial position of a company and its performance including its subsidiaries, joint-ventures and associate companies.
For example: Let us assume the example of HDFC Bank. HDFC Bank (Parent Company) has many subsidiaries like HDFC Life Insurance, HDFC Asset Management Company (AMC), NextGen Publishing to name a few. For the purpose of understanding, let us just take three.
Now HDFC Bank performs regular retail banking operations along with running subsidiaries such as an AMC, an insurance company and a publishing house. Each of these subsidiaries adds wealth to their parent company i.e. HDFC Bank LTD.
When we consider the consolidated statements of HDFC Bank Ltd. we also consider the contribution of its subsidiaries in consideration along with the HDFC retail banking activity i.e. AMC, insurance company and publishing house plus the functioning of the bank.
Standalone Statement
Standalone financial statements consider the functioning of the company as a single entity and do NOT include the contribution of its subsidiaries.
For example: When you go through the standalone financial statements of a company, you read the financial position of the company with respect to its banking functions ONLY or all those functions which only HDFC Bank Ltd. performs as a separate entity not taking into consideration the contributions of its subsidies generally.
Consolidated or Standalone financials. What to use?
As a rule of thumb, if you want to know the total overall financial strength of the company you mostly read the Consolidated financials of the company.
When would the need to read standalone financials arise? Generally, when there is no direct business-related intervention into its subsidiaries and associates you consider the standalone statement of the company. Otherwise, when you wish to analyse the financial health of the parent company as a separate entity you may read the stand-alone statements
A good investor analyses BOTH consolidated and standalone statements to figure out shortfalls in the companies or any of their subsidiaries.
Companies often employ various strategies to reward their shareholders and strengthen their market position. Bonus shares are a way in which companies reward their existing shareholders. In this article, we will discuss what a bonus issue is, how it works, and its benefits to the company. We will also examine how it differs from dividends and stock splits.
What is a Bonus Issue?
A bonus issue is a corporate action wherein a company gives additional shares to its existing shareholders at no extra cost. These shares are proportionally allocated to their shareholding as of the record date. [To be eligible for receiving bonus shares, investors must be shareholders of the company before the record date]. The primary object of issuing bonus shares is to capitalise on the company’s retained earnings and reserves while rewarding shareholders.
A bonus issue does not increase a company’s market capitalisation, but the number of shares increases. Thus, the price reduces in the same proportion. The face value (FV) of the stock remains the same after a bonus issue.
How do Bonus Shares Differ From Regular Dividends?
Although both bonus shares and regular dividends are ways to reward shareholders, they are entirely different corporate actions. Dividends involve distributing a portion of the company’s profit in cash directly to the shareholders’ bank accounts. On the other hand, bonus issues do not provide any immediate monetary benefits. Instead, they increase the number of shares owned by each shareholder. The additional shares improve the potential earning capacity of the shareholders.
Why Do Companies Issue Bonus Shares?
Capitalisation of Profits
Accumulated profits, also known as retained earnings, are the cash that remains after a company distributes dividends to its shareholders. Bonus issues allow companies to capitalise their accumulated profits or reserves and convert them into share capital. The company can then use the capital to fund expansion, investments, and other activities.
Enhancing Liquidity
A bonus issue increases the number of outstanding shares in the company. An increase in the number of shares will dilute the share price and improve its liquidity, potentially attracting more investors.
Rewarding Shareholders
Unlike cash dividends, bonus issues are a way to reward shareholders without affecting the company’s cash reserves. It helps maintain investor confidence.
Steps in Bonus Issue
The process of a bonus issue involves the following steps:
1. Board Approval
A company’s board of directors hold a meeting to discusses whether they are in a position to issue bonus shares. If yes, the board approves the bonus issue proposal and puts the decision up for shareholder vote.
2. Shareholder Approval
Once shareholders approve, the information is made public and communicated with the Securities and Exchange Board of India (SEBI) and other organisations, including stock exchanges (NSE and BSE).
3. Bonus Ratio
A bonus ratio specifies how many bonus shares will be issued for each existing share in the company. For example, a bonus ratio of 2:1 implies that shareholders will receive 2 additional shares for each share they hold, taking the total shares held to 3 (1+2).
How is the Bonus Ratio Determined? The bonus ratio is determined by considering various factors, including the company’s financial performance, capital requirements, and market conditions. The amount of reserve or retained earnings to be capitalised also determines the bonus ratio.
4. Record Date
A record date is set to identify eligible shareholders who will receive bonus shares. Only shareholders on record on this date are entitled to the bonus. The company collects the names and details of shareholders as on the record date from depositories.
5. Issuance of Bonus Shares
After the record date, bonus shares are allotted to the shareholders in the bonus ratio.
How Do Bonus Issues Impact Shareholders?
A bonus issue affects the shareholders as on the record date as follows:
Increased number of shares
Existing shareholders receive additional shares, which increases the total shares they hold in the company. However, there won’t be any change in shareholding patterns and ownership.
No change in face value
A bonus issue does not reduce the face value of the shares.
Change in market price
The share price of the company adjusts downward after a bonus issue due to the increased supply of shares. However, this adjustment is usually temporary and will stabilise over time.
Example of a Bonus Issue
Berger Paints Ltd had recently declared the issuance of bonus shares in a 1:5 bonus ratio, which means that a shareholder as of the record date will receive one bonus share for every 5 shares held. The record date for the bonus was September 23, 2023.
If you had held 5 shares of Berger Paints Ltd on September 23, 2023, you would have received one bonus share from the company.
On the record date, the stock fell 8.65%. It fell 16.85% till October 4, 2023, when it started to stabilise. However, the fall in the stock price was purely due to the bonus adjustment that we discussed.
Benefits of Bonus Issue
Bonus shares are exempt from taxes.
It multiplies returns in the long term.
Bonus shares are free of cost to the investors.
From the company’s point of view, it helps to enhance the company’s value and image in the market. Additionally, the company will have more free-floating shares in the market with the issue of bonus shares.
How is a Bonus Issue Different From a Stock Split?
Although both bonus issues and stock splits result in an increase in the number of shares, they are completely different corporate actions with different purposes. A stock split is a corporate action in which a company divides its existing shares into multiple shares of a smaller price. On the other hand, a bonus issue is a corporate action wherein a company gives additional shares to its existing shareholders at no extra cost.
A bonus issue is a method to reward shareholders whereas a stock split is done to increase share liquidity, reduce share price and make it more affordable for more investors.
In a bonus issue, the face value of the shares does not change. However, its face value reduces in the same ratio in a stock split.
Regulatory & Compliance Requirements of Bonus Issues
In India, all corporate actions are governed by the Companies Act of 2013. According to the act, a company can only issue bonus shares to its members out of its:
1. Free reserves
2. Securities premium account
3. Captial redemption reserve account
Given below are some of the mandatory requirements that a company should comply with to issue bonus shares:
The company shall capitalise its profits or reserves for the purposes of issuing fully paid-up bonus shares subject to the following [Section 63(2) and Regulation 293]:
Authorisation by the Articles of Association
Approval of its Shareholders/Members by passing a special resolution in a duly convened general meeting, basis recommendations of the Board
No default in payment of interest or principal in respect of fixed deposits or debt securities so issued
No default in payment of statutory dues of the employees, such as, contribution to provident fund, gratuity and bonus
Make all the outstanding partly-paid-up shares on the date of allotment as fully paid-up
None of its promoters or directors is a fugitive economic offender.
The company shall abstain from withdrawing from the decision of its board recommending a bonus issue if it has been announced. (Rule 14)
The Issuer Company shall implement the bonus issue:
Within fifteen days from the date of the board meeting where shareholders’ approval is not required for capitalization of profits or reserves for making the bonus issue
Within two months from the date of the board meeting where shareholders’ approval is required for capitalization of profits or reserves for making the bonus issue. (Regulation 295)
You can read more about the regulatory and compliance requirements related to bonus issues here.
Tax Implications of Bonus Issues
In bonus issues, the shareholders receive additional shares at zero cost. However, bonus shares are subject to capital gains tax when sold. The cost of acquisition or purchase price of the bonus shares will be ₹0 as it is free. Bonus shares are subject to capital gains tax.
For example, assume you are holding 100 shares of a company that you had bought at ₹100 per share. After a 1:1 bonus issue, you will receive 100 additional shares, taking the total number of shares held to 200.
No. of shares originally held
100
Bonus Ratio
1:1
Total number of shares post-bonus
200
Purchase price of original shares
₹100
Let us assume that you sell 100 shares at ₹150 before 1 year (short-term capital gain). The taxable short-term capital gain would be;
Selling Price (100 x 150)
₹15,000
Cost of Acquisition (100 x 100)
(₹10,000)
Capital gain on sale of original shares
₹5,000
A short-term capital gain tax of ₹750 (i.e. 15% of ₹5,000) is payable.
Now you sell the remaining 100 shares (bonus shares) within the same year at ₹150. The taxable short-term capital gain would be:
Selling price (100 x 150)
₹15,000
Cost of Acquisition (100 x 0)
(₹0)
Capital gain on sale of bonus shares
₹15,000
A short-term capital gain tax of ₹2,250 (i.e. 15% of ₹15,000) is payable.
In conclusion, bonus issues are a popular corporate action used by companies to reward shareholders, enhance share liquidity, and capitalise profits. It doesn’t change the total value of your investment, but it can affect the share price temporarily. It is also crucial to be aware of the tax implications of bonus issues.
When companies wish to raise funds, they usually opt for an initial public offering (IPO) or debt issue (via bonds or debentures). But these are not the only viable options! They can also approach existing shareholders for additional funds through a method known as Rights Issue. In this article, we will explain what a rights issue is, its purpose, and how it works. Let’s also understand why companies opt for a rights issue compared to other options, its advantages and disadvantages.
Rights Issue: Explained
A rights issue is a method by which companies raise equity capital from their existing shareholders. This issue provides existing shareholders with securities known as rights. Rights give its holders an option to buy additional shares in the company at a discount. The holders can choose whether to exercise the right. Right is not an obligation to buy shares, but a mere option. Therefore, rights are valued similarly to how options are valued.
Additionally, a rights holder can sell the rights shares via the open market. There are two types of rights: renounceable and non-renounceable rights. If the rights are renounceable, you can sell them on the market like any other security.
The difference between a rights issue and fresh issues or offers for sale (OFS) is that rights issues do not dilute the ownership of existing shareholders.
What is the Purpose of a Rights Issue?
The primary reason for a rights issue is to raise money. It is a method of raising equity capital. The proceeds from the issue will fund various financial initiatives of a company, such as servicing or reducing debt, funding new projects, or simply increasing their cash reserves.
Why Do Companies Opt for Rights Issues?
Compared to other methods, a company may opt for rights issues mainly to retain control and ownership. Issuing new equity shares will dilute the ownership of the existing shares. Dilution occurs because a rights offering spreads a company’s net profit over a larger number of shares. Thus, the company’s earnings per share (EPS) decreases as the allocated earnings result in share dilution.
Before raising new capital from outsiders and diluting the existing shares, a company provides its existing shareholders (including promoters) the opportunity to participate in the capital raising. Therefore, this type of issue is more favourable to the existing shareholders.
Dilution of ownership will also reduce the voting rights of the current shareholders, especially promoters. The discount offered will compensate the investors for the ownership dilution.
How do Rights Issues Work?
Here’s a step-by-step explanation of how a rights issue typically works:
1. Rights Issue Announcement
Before announcing, the company’s board of directors have to approve the decision to raise capital through a rights issue. The number of shares to be issued and the price at which they will be offered is calculated. The price will be at a discount to the current market price. Once all the procedures are completed and the compliance requirements are satisfied, the company will announce the right issue. The announcement will be through various channels such as a regulatory filing with the exchanges, email, and other forms of media.
The issue will also be guaranteed or underwritten by underwriters.
Legal Requirements to Issue Rights
In India, companies are governed as per the Companies Act. Section 62 of the Companies Act, 2013, relates to the ‘further issue of share capital’ and lays down the regulatory or legal framework for rights issues. You can read about the legal requirements here.
2. Declaration of Record Date
The company will establish a record date. Only the shareholders that hold the company’s share on the record date will be eligible for the rights issue. If you own shares before this date, you’ll generally receive rights based on your existing ownership.
3. Issuance of Rights
On the specified date, the company issues rights to existing shareholders based on their current holdings. Each right represents the opportunity to buy a certain number of new shares at a discounted price.
4. Trading of Rights
If the rights are renounceable, they can be traded in a secondary market. The period during which these rights can be traded is known as the “rights trading period.” Shareholders who may not wish to buy more shares can sell their rights to other investors interested in acquiring the discounted shares.
5. Decision by Shareholders
Shareholders have the option to do one of the following during the rights issue:
Exercise Rights: Shareholders can use their rights to buy new shares at a discounted price. This maintains their ownership stake in the company, preventing dilution.
Sell Rights: Shareholders can sell their rights to other investors. This allows those investors to buy the discounted shares.
Do Nothing: Shareholders who neither exercise nor sell their rights may let them expire. This results in the dilution of their ownership stake.
6. Proceeds to the Company
The company collects funds from shareholders who choose to exercise their rights. These funds are used for the intended purpose, such as debt repayment, expansion, or other corporate initiatives.
7. New Share Issue
After the rights issue period concludes, the company issues new shares to those shareholders who exercise their rights. The number of new shares issued corresponds to the total rights exercised.
8. Ownership Changes
Shareholders who exercise their rights will not be subject to an ownership dilution. Shareholders who did not participate in the rights issue will experience dilution of their ownership stake as a result of the new shares issued.
What Happens When a Company Announces a Rights Issue?
A rights issue increases the number of shares in the market. This will reduce the company’s Debt-to-Equity ratio as there is an increase in equity. This makes it availing additional debt easier for the company.
More importantly, the Earnings Per Share (EPS) of the company reduces. EPS is essentially the profit generated by the company for each of its equity shares. It is calculated by dividing the net profit attributable to equity shareholders by the weighted average number of equity shares for the year. A reduction in the EPS is unfavourable.
Terms in Rights Offering
Rights Issue Ratio
A rights issue ratio specifies how many new shares a shareholder is entitled to purchase or subscribe to for each share they currently own. It determines the proportion of new shares that existing shareholders can acquire.
For example, a 1:10 rights issue means that an existing shareholder can buy 1 share for every 10 shares currently held.
Subscription Price
The subscription price refers to the price at which existing shareholders can purchase additional shares as part of the rights offering. It is also known as the exercise price and offer price.
What is an Ex-Rights Date?
The ex-rights date is the date on which the shares of the company begin trading without the attached rights to purchase additional shares at the discounted subscription price.
How to Subscribe to a Rights Issue?
When you are an existing shareholder on the record date, you get Rights Entitlement (RE) shares in your account. The RE will be in the form of temporary Demat securities that will expire if not used for the application or sold. If you do not wish to avail it, you can either usually sell the RE shares in the secondary market, or let it lapse.
To apply for a rights issue, shareholders can use the Applications Supported by Blocked Amount (ASBA) process if their bank supports it. It is very similar to applying for an IPO.
Alternatively, the company’s Registrar and Transfer Agent (RTA) will send a Composite Application Form (CAF) via courier to those who cannot apply online. The filled form can be submitted at a Self-Certified Syndicate Bank (SCSB) branch. The forms can also be downloaded from the BSE and NSE websites.
Advantages & Disadvantages of Rights Issue
Advantages
Disadvantages
Prevents ownership dilution of existing shareholders (if the right is exercised)
This may result in concentrated investor positions compared to those who didn’t exercise the right
It shows the company’s commitment to its existing shareholders
Additional required filings and procedures associated with the rights offering
A quick way to raise equity capital
Can only raise limited capital
Example of Rights Issue and Outcome
In 2020, Reliance Industries Ltd (RIL) announced a rights issue to raise capital for reducing debt and funding its ambitious expansion plans, particularly in the digital and retail sectors. The company issued one right share for every 15 shares held by existing shareholders. The subscription price was ₹1,257 per share, which was significantly lower than the market price at that time.
For instance, if an investor held 150 shares of Reliance Industries before the rights issue, they were entitled to purchase 10 additional shares at ₹1,257 each. This opportunity allowed existing shareholders to increase their stake in the company at a discounted rate.
The rights issue was part of RIL’s broader strategy to become a global digital and retail powerhouse. The offering was a massive success, receiving overwhelming participation from existing shareholders and even attracting interest from institutional investors. The proceeds from the rights issue, which amounted to around ₹53,124 crore, provided RIL with the financial strength to continue its ambitious growth initiatives.
A stock split is an action in which a company divides its existing shares into multiple smaller shares. However, the market capitalisation of the company remains unchanged. A stock split does not dilute the ownership of shares. In this article, we will understand what a stock split is, the key factors driving it, its importance, and its advantages & disadvantages.
What is a Stock Split?
A stock split is a corporate action in which a company divides its existing shares into multiple shares of a smaller price. The primary goal of a stock split is to increase the number of outstanding shares while decreasing the price per share. This process does not affect the company’s market capitalisation or total value.
A company generally announces a stock split to make it cheaper to buy, making it more affordable for a small retail investor. It increases the demand for the stock and provides the company with liquidity (or cash in hand).
For example, the current market price of MRF Ltd is ~₹1,09,000 per share (as of September 28, 2023). Most retail investors would not be able to buy even 1 share of the tyre manufacturer. However, they are more likely to buy it if the shares are priced at ₹1,000. The company can do a stock split in this situation to make it affordable for retailers.
Impact of Stock Split on a Company:
Market capitalization remains the same.
Demand for stock increases.
Share price: First decreases and then gradually starts to increase.
A stock split is a process that involves dividing a company’s existing shares into a larger number of new shares with a lower price. Here’s how it typically works:
1. Company Decision
A company’s Board of Directors decides whether to initiate a stock split. The decision is usually taken in response to various factors, such as the desire to make the stock more affordable for investors or increase liquidity. However, it also reduces the company’s Earnings Per Share (EPS), making it less attractive.
2. Announcement
After the decision is made, the company publicly announces the stock split. In the announcement, the company will specify the split ratio (e.g., 2:1, 3:1, etc.) and the split’s effective date.
What is a Split Ratio?
A split ratio is a numerical expression that indicates how a company’s shares will be divided or split during a stock split.
Consider a split ratio of 2:1. The company increases the number of its outstanding shares by dividing each existing share into two new shares. This means that for every single share an investor owns before the split, they will receive two shares after the split.
For example, if you own 100 shares of a company’s stock trading at ₹100 per share, and the company undergoes a 2:1 stock split, you will now own 200 shares, but each of these new shares will be valued at ₹50. The overall value of your investment remains unchanged at ₹10,000 (100 shares x ₹100 before the split = 200 shares x ₹50 after the split).
3. Record Date
The company determines a record date, also known as the “split date.” Shareholders who own the stock on this date will be eligible to receive the additional shares resulting from the split.
4. Split Execution
On the effective date, the stock split is executed. For example, in a 2:1 stock split, for every share a shareholder owns, they will receive two new shares. The total number of outstanding shares increases, but the individual share price decreases proportionally.
5. Demat Credit
The additional shares resulting from the split are credited to the shareholders’ demat account. Shareholders do not need to take any action to receive these additional shares.
6. Adjusted Share Price & Trading
After the split, the share price is adjusted to reflect the new ratio. For example, if a company’s stock was trading at ₹1,000 per share before a 2:1 split, it would trade at ₹500 per share after the split. The trading symbol for the stock remains the same, only the price and the number of shares available have changed.
How Does a Stock Split Affect Share Price, Volume, and Liquidity?
Share Price
When a company does a stock split, they make more shares, and each one becomes cheaper. For example, suppose you had one stock worth ₹1,000 before. After a 2:1 split, you’d have two shares, and each would be worth about ₹500.
This lower price often makes it more affordable to investors. So, more retail investors might want to buy the stock, even if they couldn’t before because it was too expensive. But in the short run, the price can get volatile.
Volume
After a stock split, the volume of trading in the stock increases as the shares are now cheaper.
Liquidity
Liquidity refers to the ability to buy and sell stock at the desired price without significantly affecting the stock’s price. Stock splits improve liquidity by increasing the number of shares available for trading. Lower share prices resulting from a split can make the stock more accessible to a wider range of investors, including retail investors. This increased accessibility can further boost liquidity as more investors participate in trading.
Practical Examples of Stock Split
Example 1: A company ABC, whose value of each share is $30, announces a stock split such that the value of each share is 1/3rd the value of its original price. The company does so by dividing the value of one stock by three. Therefore, the value of each share will become $10, and the sum of three such stocks will be $30. So the value held by investors remains constant.
Example 2:
Let us assume that you hold 100 shares of Reliance Industries (RIL). Each share of RIL costs Rs. 1,000. Therefore, you hold shares worth ₹100,000 in total.
Let us also assume for convenience that the total number of outstanding shares is 1,000,000 (1 million). So market capitalization will be 1,000,000,000 (1 Billion).
One fine day, RIL announces a stock split in the ratio 1:1 (one extra share for every one share held in the company). This means that the total number of outstanding shares will be 2,000,000 (2 Million) but the market capitalization still remains 1 Billion at the moment.
When RIL announces the stock split, the number of shares you held would double. But their total value still remained the same i.e. ₹100,000. And the value of each share that you hold will be half i.e. Rs.500 (₹1,000 divided by 2).
After this, you can expect a decline in price due to the excess supply of shares in the market. Later, the price will surge due to increased demand, thereby raising liquidity for the company.
Advantages and Disadvantages of Stock Splits
Advantages
Disadvantages
Stock splits result in more shares being available in the market, which can increase trading activity and liquidity. It will make it easier for investors to buy and sell shares.
A stock split doesn’t change the fundamental value of a company. If the stock was overvalued before the split, it will still be overvalued after the split.
After a stock split, the share price typically decreases. This can make the stock more affordable to a wider range of investors, potentially attracting new buyers.
Buying or selling more shares due to the split may result in increased transaction costs, especially if investors/traders have to pay commissions or fees for each trade.
A stock split can create a positive perception among investors. It may be seen as a sign of confidence by the company’s management, which can boost investor sentiment.
The company needs to pay different costs like legal & exchange fees while splitting its stock.
In conclusion, a stock split is only a corporate event that adjusts the number of shares and their prices. However, it doesn’t alter the company’s fundamentals, unlike other corporate actions such as a bonus issue. Stock splits are often welcomed by investors because they make shares more affordable and boost trading activity. Remember, always study and understand a company’s fundamentals before investing!
Repo-Rate is the interest rate at which a central bank (like RBI) lends money to all the other banks in the country. Essentially, all banks give out loans, pay their employees, maintain systems and perform other functions for which they need money.
There are many ways in which a bank earns money, one of them is borrowing from a central bank at a lower interest rate and lending it out in the market at a higher interest rate. The difference between these interest rates becomes their profit.
For example,
1. The Reserve Bank of India (RBI) lends money to banks at 2% and these very same banks lend out money to the market, which consists of consumers, suppliers, businesses etc.
2. The market uses the money to flourish the economy by scaling up production, increasing revenue and profits and other such activities.
3. Once the market has managed to earn sufficient money, it reciprocates by giving the money back to the banks with an interest of 8% (i.e. 8% more than the money they borrowed from the bank).
4. The bank then goes on to pay back the money to the central bank at 2% interest. The difference between 8% and 2% = 6% is essentially the bank’s profit, which it can further lend to the market.
Repo Rate and Interest
When the central bank increases the repo-rate the interest rate also goes up and the supply of money decreases
When the repo rate decreases the interest rates also decrease and the supply of money in the market increases.
What is Reverse Repo-Rate?
There can always arise a need when there is excess surplus money lying in the market and/or the central bank itself is in need of money, The bank decides on the reverse repo rate or the rate at which other banks lend money to the central bank.
Why is Repo Rate Higher than Reverse Repo Rate?
Banks can park their money with the RBI at a lower interest rate than the Repo Rate or Repurchase Rate. The Reverse Repo Rate is lower than the Repo Rate. The spread between the two is the RBI’s income.
