Does a stock-split signal a buy?

What a feat by Apple Inc! The maker of iPhones, Mac computers and Apple watches achieved the milestone of hitting $2-trillion market capitalisation mark. It became the second company in the history of stock markets, after the recently-listed Saudi Aramco. However, Saudi Aramco could not sustain that level due to the meltdown in crude oil prices and the global economic pressures since its listing in December 2019.

So, what propelled Apple to the $2-trillion market cap level? Stock split, for one.

A stock split is the division in the face value of a company’s existing shares into multiple new shares. Companies generally go for a stock split to boost liquidity in the stock exchange(s). The number of outstanding shares increases by the exactly ratio, and the total value of the shares (or the market cap) remains the same, as the split does not add any value to the shares.

$1 trillion in 2 years

While it took 42 years for Apple Inc to reach the $1 trillion-mark, it added another $1 trillion in just two years.

So, what fuelled the rally? While Apple’s fundamentals are strong, one factor that helped the stock reach Mount $2-t quickly was its recent announcement of a stock split. Apple Inc announced a 4-for-1 stock split. The split will take effect from August 31 (ex-date) for shareholders of record date August 24. As the record date approaches, there is naturally heavy demand for the stock. Apple Inc shares are currently hovering around $470 a piece. The stock has gained almost 23 per cent, since it announced the stock-split.

Not just Apple, Tesla Inc too announced a 5:1 stock split. The stock will also turn ex-date on August 31. From $430, shares of Tesla moved past the $2,000-mark for the first time on August 20, as it set the record date of August 21.

It’s not just a global phenomenon. Even the shares of iconic Royal Enfield motorcycle maker Eicher Motors jumped 50 per cent after the company announced stock-split plans in May. The board on June 12 approved a stock split in the ratio 1:10 (that is, face value reduced from ₹10 to ₹1). The stock will turn ex-date for stock split on August 24 (Monday).

SEBI relaxation

In India, initially companies were allowed to keep the face value only in multiples of ₹10, that is, ₹10, ₹100 or ₹1,000. However, in 1999, SEBI gave comanies the freedom to set the face value of their shares, mainly to facilitate more companies to raise funds through initial public offerings. It was then felt that by sticking to the ₹10 face value, most companies’ share prices, based on their valuations, may be out of reach of retail investors.

This saw a number of companies reduce the face value of their shares to as low as ₹1, so that they remain active among investors/traders in terms of being liquid on the exchanges. However, unlike in the US market, Indian companies are not allowed to have face value of shares in fractions. Still there are some companies such as Victoria Mills, Bombay Potteries & Tiles, Bombay Oxygen Investments, and Lakshmi Mills, whose face value is ₹100.

Be cautious on stock split?

Though stock splits tend to make pricey shares more affordable for small investors as well as to fund houses looking to tone up their portfolios, investors should not make their buying decision based on stock splits alone. As the stock split does not alter the fundamentals of the company, the sharp rise in the share price may not sustain.

The initial reaction could be due to the higher demand in the secondary market. Though stock split may be an important tool for company managements to enhance shareholder wealth, some promoters may misuse it to prop up stock prices artificially. Thus, stock splits do pose some challenges to investors in identifying good stocks.

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