How to profit from share splits

Finweek English Edition - - FRONT PAGE - BY SIMON BROWN ed­i­to­

One trend which we’ve been see­ing over the past few years is a num­ber of share con­sol­i­da­tions, with the most re­cent be­ing South African IT com­pany Gi­jima and con­struc­tion com­pany RBA. What we’re not see­ing is the other side of a con­sol­i­da­tion: the share split.

Let’s look at what they are, how they work and how we can profit from them.

A share con­sol­i­da­tion re­duces the num­ber of shares in is­sue and pushes the price higher. Say for ex­am­ple a stock is trad­ing at 10c and there are a mil­lion shares in is­sue which the di­rec­tors may de­cide to do a share con­sol­i­da­tion. The logic is that a 10c share has at least a 10% spread (dif­fer­ence be­tween buy­ers at 10c and sell­ers at 11c). For many that 10% spread is sim­ply too wide to cross as it adds risk to the pur­chase.

So, the com­pany could do a 10:1 (10 for one) con­sol­i­da­tion and in­stead of 1m x 10c shares there would be 100 000 x 100c shares. The value of the com­pany is un­changed at R100 000. But at 100c the spread can be as low as 1c and the stock seems less dicey as a true penny stock.

This last point may just be win­dow dress­ing but that’s of­ten the na­ture of the mar­kets. Cer­tainly noth­ing has changed about t he com­pany or its val­u­a­tion, just the price of the share.

The in­verse of a con­sol­i­da­tion is a share split. Take for ex­am­ple Naspers* cur­rently trad­ing at around R1 700. Now, in truth, most trans­ac­tions are for well above R1 700 and whether you buy two shares or 2 000 shares the real is­sue is not the quan­tity, but the value in­vested.

A 25% in­crease in a 20c stock is ex­actly the same as a 25% rise in a R1 000 stock.

It is fun­da­men­tals and mar­ket sen­ti­ment that drive share prices.

That said, we have seen some share splits in the past and they work in the re­verse of a con­sol­i­da­tion.

So, stay­ing with Naspers, i f the com­pany did a share split 10:1, the price would drop to R170 (10th of the cur­rent price) and your quan­tity of shares would in­crease ten­fold.

So the share­holder is left in ex­actly the same po­si­tion, but the the­ory is that at a lower price level liq­uid­ity is im­proved.

Share con­sol­i­da­tions were ver y popular in the dot-com bull mar­ket, but have gone out of favour in the last decade or so. Part of the is­sue is that di­rec­tors could look very silly if they split the share only to watch it crash lower, maybe re­quir­ing a con­sol­i­da­tion.

So, as a share­holder i n ei­ther a split­ting or con­sol­i­dat­ing share noth­ing re­ally changes ex­cept for the quan­tity and price of the shares you hold. The value of the hold­ing re­mains the same. But the price ac­tion af­ter a share split or con­sol­i­da­tion usu­ally re­sults in ei­ther a profit or a loss.

Share con­sol­i­da­tions are typ­i­cally neg­a­tive for a share price. RBA was around 13c be­fore the con­sol­i­da­tion pushed it up to a the­o­ret­i­cal 130c and as I write it has drifted down to be­low 100c. A weaker share price is the norm for con­sol­i­da­tions. On the f lip side, share splits gen­er­ally see the price mov­ing higher af­ter the split as smaller pri­vate clients start buy­ing in the mis­placed view that cheaper is bet­ter.

So buy splits and sell con­sol­i­da­tions.

Many will tell you that a R1 000 stock can­not 25%eas­ily go up or more, but I re­fer you to the Naspers price that has traded as low as R983 and as high as R1 744 in the past 12 months.

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