Oran Hall | Financial Adviser | The attractiveness of stock splits

Question : Should I buy a stock that has had a stock split?

FINANCIAL ADVISER: A stock split is a subdivision of shares to reduce the price of the stock to a level within which most stocks trade. The more successful companies are, the more likely it is that their stock will trade at high nominal prices, so they tend to be the ones that have stock splits.

The process by which a stock split comes about is generally like this. The directors propose it, and it is then put to the shareholders at a regular or extraordinary meeting of the shareholders for their approval. An annou-ncement stating the basis of the split such as it being a two for one split is then made. The record date and payment date - the date on which the stock split takes effect - are also given.

The record date is important. It is the date that determines who is entitled to the stock split. Shareholders whose names are on the shareholders register are the ones eligible for the stock split. The register generally closes a few days before the record date on what is called the ex-stock split date.

Purchasers of stock from then to the payment date are not eligible for the shares bearing the old nominal value, a fact that is reflected in the price being adjusted to reflect the split. This means that 10,000 shares bought in the ex-stock split period will not become 40,000 shares, where there is a four for one split.

The stock split affects the total number of shares in issue, the par value of each unit of stock, the number of shares each shareholder owns, the market place, and the dividend per share.

Brings about change

A stock split brings about a change in the number of shares due to a change in the par value of the shares. If, for example, a company having 10 million units of stock in issue declared a four-for-one stock split, the number of issued shares would increase to 40 million.

Similarly, the owner of 100,000 shares in Company X would own 400,000 after such a split. The above changes would happen because of the change in the par value of each unit of stock. The par value of $1 would change to 25 cents in the case of a four-for-one split.

The price of the stock is also adjusted to reflect the changes brought about by the issue. If, for example, the stock traded at $24 before the split, the price after the split would be $6, all things remaining constant. Dividends would be affected the same way unless the directors recommend, and the shareholders approved, a higher rate of dividend. The increase in the issued ordinary stock units of the company would also cause a corresponding reduction in earnings per share.

A stock split is not a distribution by the company to shareholders as is the case with a bonus issue, and all shareholders on the share register of the company on the record date of the issue are eligible for the stock split. It is not renounceable. Shareholders are not required to pay for the additional shares.

There is no change in shareholders' equity. In other words, the value of the shareholders' funds is not disturbed, although there is a fourfold increase in the shares owned by the shareholders.

The split does not yield any money to the issuing company or cause the company to pay money to shareholders. Shareholders, on the other hand, come into possession of more shares and, quite likely, without any increase in their wealth. To sell any would make them own a smaller portion of the company than before. Selling is not likely to yield a windfall considering the price adjustments that the new shares would make necessary.

A stock split increases the liquidity of the stock due to the increase in the number of shares and their lower nominal price. The demand for a stock that is to have a split often increases before it becomes effective due to the perception that there is a benefit to be gained. This is not necessarily so as the price could decline below the effective pre-stock split level if it had risen too much or if shareholders were to opt to sell heavily after the split takes effect.

On the other hand, the decline in the dollar value of the stock would make it more affordable to more investors and may thus cause an increase in demand, leading to the price appreciating.

Buy a stock if its fundamentals are sound, for it should yield good returns in the future. A stock split should not weigh heavily in your decision to buy a stock.

- Oran A. Hall, principal author of 'The Handbook of Personal Financial Planning', offers personal financial planning advice and counsel. finviser.jm@gmail.com