How to profit from share splits
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.