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What Is a Stock Split?
Sunday, July 22, 2007
A stock split occurs when a corporation decides to issue new stock and distribute it to it's current stockholders. This is a decision made by the company's board of directors.
The most common stock split is a 2 for 1 split. When this happens the stockholder will now own twice as many shares as before the split but at half the price. The total value of your stock does not change. For instance, if you owned 100 shares before the split and the price was $50 a share, after the split you would own 200 shares at $25 a share. After the split the shareholder owns exactly the same percentage of the company as before the split, only the number or shares and share price has changed.
While a 2 for 1 split is the most common, companies also distribute 3 for 1 splits, 3 for 2 splits, 5 for 1 splits, etc.
Why does a Company Split their Stock?
Companies will split their stock when they feel that the share price has grown to the point that it will no longer be considered affordable by many investors. Since most stock transactions are in round lots (lots of 100 shares), the total cost for 100 shares might be out of reach for some investors. Once a stock price hits $100 a share, for instance, evidence shows that many investors consider it to be too expensive. If the price per share were reduced it would be more affordable. The effect of more people buying the shares will hopefully lead to a price gain.
What effect does a Stock Split have on the Share Price?
When a company splits it stock it sends the message that the company has been profitable and it will probably continue to prosper. Companies normally announce their upcoming stock split some time in advance. Many investors and traders search for these companies and consider them prime candidates for a further price increase.
In theory a stock split should have no impact on the value of the stock, it should be a neutral event. The only thing that has changed is the share price and number of shares. When you do the math you still have the same value and the same percentage of ownership in the company. In practice however, companies who split their stock most often see price increase when the split is announced or after the split actually occurs. The company knows this and is eager to see it's stock price increase.
Reverse Split
Sometimes a company will issue a reverse split. When this happens the shareholder will have less shares at a greater price. For example, a typical reverse split is a 1 for 10 split. For example, if a company has been trading at $1 a share and you have 100 shares, after a 1 for 10 split you will have 10 shares at $10 a share. A company might perform a reverse split when their share price has dropped to a very low level and they want to increase the share price to appear more respectable to potential investors. In addition, some exchanges will de-list a stock when the price drops below a certain level for 30 days.
Why portfolio review is a must
Sunday, April 22, 2007
Of course, an occasional tweaking of your portfolio is also necessary to keep you abreast with the existing market situation. But remember that occasional tweaking could even mean no tweaking, at times.
As the legendary investor, Warren Buffet has said, "Occasionally successful investing requires inactivity. "But often it is necessary to take a fresh look at your portfolio when the markets rise too quickly or fall flat.
You will need to answer important questions about your investment goals before shifting money from one investment to another..
Remember portfolio review is like going for a yearly medical check-up. You may not be exactly ill but a yearly executive check-up ensures that diseases don't crop up suddenly.
The idea is to take precautionary measures. And it depends upon the results of the check-up that the doctor decides what treatment you may need or none at all.
Similarly, if one is going through a portfolio review during/after a bull run and feeling jittery about the market conditions, it is a good idea to book profits. But equally important is to keep a gameplan ready before you start gathering all that cash on what will you do with the sale proceeds.
In other words, you need to be very clear whether you intend to plough back the sale proceeds into some other instrument or purchase a home or reinvest it somewhere else. Let us look at a couple of situations.
One, are you going to invest the proceeds in another equity fund after encashing from one that has seen major upside? - It is always good idea if one has been able to spot the next winner. But switching money from one fund to the other just because the net asset value (NAV) of the other fund is lower than the first is never a smart move.
Often, we fall for the Rs 10 trap or the NFO trap. Just because a fund is being launched at an offer price of Rs 10 (or at par value - as many refer), the fund does not become a good option or even a safer option. Remember whether the NAV of a fund is high or low, has no relation to how a fund would perform in future.
Two, are you going to keep the money in cash/money market funds and wait for the "correction"? There have been many instances of investors waiting for the correction in the market and the market continues to go upwards.
Timing, at best, is an extremely difficult proposition and generally an impossible one. One would be better off - financially and emotionally - without resorting to timing the entry and exits in the investment markets, especially in those of volatile nature.
And even if the markets were "incorrect", remember what John Maynard Keynes said, "Markets can remain irrational longer than you can remain solvent".
In other words, any action that one may need to take, thus, has to be a part of a broader investment plan involving various factors. Investor's needs, the risk taking ability and the time horizon are the most important factors. All these change with time and circumstances. Most often these circumstances are specific to an individual rather than general like change in market conditions.
A recent change in the structure of interest rates is a good example of a general situation, which has adversely impacted the markets. In this scenario, it is a good to review one's portfolio. If the preferred investment vehicle has been mutual funds, you have outsourced the job of taking a view of the market to a professional manager.
However, if you have taken a home loan, it could be a good idea to liquidate your investment portfolio to repay the loan, if it is on a floating rate. For instance, a year back the floating rate for home loans were hovering around 9 per cent . Now they are up to around 11 per cent. If an investor expects the equity market to deliver 12 per cent to 15 per cent over the next five years, the gap between returns from portfolio and the cost of borrowing (even after adjusting for the saving in tax) would be high for the risk that equity market carries.
At the same time, the profits of the companies may get adversely affected because of higher cost of borrowing, leading to lower returns from the equity investments. So, when the returns are getting lower and borrowing cost is getting higher, it makes sense to reduce your borrowings as well as the costs involved. This ensures that you do not feel the financial burden in the interim period.
5 money lessons to get rich
Saturday, April 21, 2007
A investment advisor, get lots of queries from investors across the country. Here's a sample:
* 'I bought this scrip last week and it is down. Should I sell?'
* 'The markets are trading at a peak. Is it right to invest now?'
* 'I want to make maximum returns in minimum time. Suggest some stocks.'
* 'Which are the stocks worth buying with price less than Rs 50?'
* 'When will the market correct? I want to invest in some good shares.'
This kind of approach to investing in equity is a recipe for disaster. There are some serious problems here. Let's pick up some important lessons.
Lesson #1
The moment the prices of scrips drop, say, by 5%-10%, we get worried. In that anxiety, we want to sell and get out.
Let's say the Reliance share you bought last week is down 10%. So what? Will Reliance business close down? Or will Mukesh Ambani run away with your money? No.
The movement in stock prices has no impact on the business. Reliance will continue to make profits and grow. Mukesh Ambani will continue to build world-class projects. If that is the case, Reliance shares will see new heights in future. Why bother about these falls which likely will only be temporary?
The problem is, we buy stocks, not businesses. The Tatas and Birlas have been around for over 100 years. Hundreds of successful companies have run for decades and continue to grow irrespective of the stock market volatilities.
Yes, some businesses succeed, some fail. There are ups and downs. That is the inherent nature of a business. But, in the long run, they will make profits and grow. That is where management counts. Good managements run profitable operations.
Second, that's why we diversify. Even if we lose money in a few stocks, we will still make lots of money in others.
Moral: Buy businesses, not stocks.
Lesson #2
Recently, I read that if you had invested Rs 1 lakh in Infosys at the time of IPO, it would be worth about Rs 64 lakh now. But how many people made that kind of money? None, I guess, except the employees and a lucky few who bought the shares but forgot about it.
Answer honestly: wouldn't you have sold the shares when it doubled or tripled or became a ten-bagger? How many of us would have had the patience to hold on?
The problem is, we watch stock prices, not businesses. If people had kept track of the business, they would have seen the company had the potential to grow at 30%-40% per annum. Then they would have never sold their shares.
I know many people who got out at 10,000 Sensex levels, thinking the markets will correct and they will re-enter at lower levels. They are now ruing their decision. The problem: they were so obsessed tracking the Sensex that they didn't see strong economic and business growth.
Moral: Watch business growth, not rise in stock prices.
Lesson #3
The moment people buy a stock, they expect it to double soon. They see the stock ticker 10 times a day. They call their broker a couple of times daily to find out what is happening.
I have one question for such people. Can you set up a steel plant in one day? Can you build a power plant over the weekend? Can you start a mobile company and expect to have 1 million customers on Day 1? No.
Businesses take time to set up, acquire customers and generate profits. Only when the companies increase their profits will the share price also increase.
Therefore, having bought a good business and good management, give it time to prosper. If you don't have the patience, you might as well go to a casino or call-up Shah Rukh Khan at KBC.
Moral: The stock market is a serious long-term business, not a make-money-overnight casino.
Lesson #4
Another interesting aspect is the stories we hear in local trains, buses, parties, offices, of how so-and-so doubled/ tripled his money.
We end up feeling like fools not to invest in the market. At the first opportunity, we buy a few stocks without proper research and understanding.
I am not saying they are lying. But I would like to ask them about their other investments too. More often than not, for every successful investment, they would have made five other poor investments and lost money. They won't tell you about those.
The point is, when our investment is motivated by others' half-truths, we never have the patience and discipline required for successful equity investing.
Moral: Don't be fooled by others' so-called success stories.
Lesson #5
As I mentioned earlier, people sold looking at the Sensex levels and lost out on the huge potential profits. There are many waiting for the Sensex to fall to the 'right' levels to enter the market.
There are two points here. I highlighted one earlier: watch the economy not the Sensex.
Second, timing. Given that humans can switch from irrational exuberance to extreme pessimism and back in a matter of days, I believe even God will find it difficult to time the markets.
Moreover, I bet not even 1 per cent of you will enter the markets if they started crashing from tomorrow. The
So I suggest let's get over this fixation with timing the markets. Let us look at business potential and invest with a long-term perspective.
Moral: Time in the market is more important than timing the market.
Discipline and patience. That is the mantra to creating wealth on the stock markets. Unfortunately, both are in short supply. If you have them, you make your riches. If not, you could be in trouble.
I am not very sure how many would agree with the above lessons or even follow them. Such is human nature: guided by greed and fear, than by reason and logic
