The Hindu Business Line : Hair-splitting on stocks

THE PROPOSAL OF the Secondary Markets Committee of the Securities and Exchange Board of India to place a restriction on the use of stock splits appears ill-conceived. Only companies whose shares trade at a price upwards of Rs 500 are to be allowed to split their stock — reducing the face value and, correspondingly, increasing the number of shares. Only a small set of companies limited to those with a large market capitalisation or prominent among the `mid-cap' ones will be eligible to split their stocks as they alone would fulfil the minimum market price criterion now being proposed. Even for such companies a stock split may serve no bigger a purpose than making the shares affordable to a larger community of what would already be a substantial base of investors in them. But the SEBI Committee proposal would hurt the interest of shareholders in a host of mid- and small-cap companies whose shares suffer from low trading volumes.

The freedom to undertake a stock split could potentially generate larger trading volumes and thereby attract institutional investment interest with all the beneficial implications on share price that such interest might trigger. In the strong bull run that has been underway over the past six months, a host of mid-cap companies, whose shares have traditionally suffered from low liquidity, have split their stock. This has led to enhanced interest in these stocks from institutional investors, as they are comfortable with higher trading volumes. A high trading volume not only mutes the impact on price that a surge in buy/sell interest may generate but also ensures that investors do not over-pay for trying to pick up significant stake in them.

The emergence of institutional investor interest has improved the price earnings multiples of such stocks and is a positive for the shareholders, especially if it is sustained . The reasons cited by the SEBI Committee to impose the restriction appear tenuous and betray an over-zealousness to serve the interest of investors. Its contention that stock splits make inter-firm comparison difficult is not of much significance. Stocks splits do lead to a divergence in absolute prices and per share numbers linked to earnings, book value and cash flows. But without stock splits, too, the divergence is considerable among stocks of companies from even one industry.

Eversince stock splits were first allowed the face value of shares of companies have started to differ considerably. Most companies that made an initial public offering over the past three years have designated different face values for their shares, as the concept of fixed par value, is no longer in vogue. But key valuation parameters such as return on shareholder funds, return on capital employed and price earnings multiples remain unaffected. Investors have had no problems making a comparison and coming to prudent investment decisions. The SEBI Committee has not provided any evidence of stock splits hurting investor interest. In the event, no company deserves to be deprived of potentially value-enhancing options such as stock splits just because its share is quoting below Rs 500.

Article E-Mail :: Comment :: Syndication

Stories in this Section
Hair-splitting on stocks

Shareholders: Owners or speculators?

Job creation: Not just an economic problem

Footprints beyond 2003

Reflections on scoring a century

MFs must discourage short-term investments

Right to protest: At what cost?

Lunging Lyngdoh

Power reforms

Asian Bond Fund