How to profit from share splits

Finweek English Edition - - FRONT PAGE - BY SIMON BROWN ed­i­to­rial@finweek.co.za

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.

Newspapers in English

Newspapers from South Africa

© PressReader. All rights reserved.