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A stock split is a corporate action where the company decides to increase the number of shares outstanding while lowering the price per share accordingly. The nominal value of shares outstanding remains unchanged as compared to the pre-split amount.

 

A case in point is the most recent event where The Hourglass Ltd (SGX: E5P)has announced on 2nd Sep 2014 that it will do a 3-for-1 stock split where for every share held by the Group’s shareholders, they will each be entitled to an additional of 2 shares. As at the date of announcing a split, the Group has had 235,003,960 issues shares; post-split will cause increase of issued shares to 705,011,880. Additional shares which are created will have an equal ranking (i.e. pari passu) to the initial shares outstanding.

 

When Would a Stock-split Occur?

A split usually occurs if management decides to reduce the buying price of a stock to a psychologically comfortable level for retail investors. If retail investors were to purchase highly priced such as Jardine C&C Ltd (SGX: C07) where each trade requires S$44,000 (as at 05 Sep 2014), it would be difficult for them to accumulate the same shares over a period of time. Moreover, this

 

Why Would Management Do a Stock-split?

A stock-split adjustment would not fundamentally change anything to the company’s business nor its valuation. Stock-splits are expected to increase the attractiveness of the company’s stock to retail investors as the share price gets reduced. Management of the company hopes it would encourage greater participation by investors who might have a smaller capital base and would ease trading flexibility for these investors. Over time, this would not only increase the number of investors on the company but it would also enhance the liquidity of the shares floated in the market over time. Moreover, an increased liquidity would narrow the bid-ask spread of each stock.

 

How About a Reverse Stock-split?

A reverse stock-split reduces the number of shares outstanding by consolidating the current number of shares outstanding. This increases the share price of the company. The motivation of such a corporate action would be to maintain the listing requirements of the company on a stock exchange since there is usually a minimum price required for the stock to stay floated. Another benefit of a reverse stock-split would deter shorting of the stock as it would be harder to borrow with less shares being floated and with limited liquidity, it would add on to the cost of transaction as the bid-ask spread increases.

 

Value In Action

Stock-splits in theory would not have an effect on the stock’s price. However, the renewed interests by investors after the adjustments might create a positive impact to the share price which might potentially induce a rally.

 

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All views and opinions articulated in the article were expressed in Willie’s personal capacity and do not in any way represent those of his employer and other related entities. Willie does not own any shares in the companies mentioned above.

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