- Wealth PMS (50L+)
One of our portfolio stocks, Deepak Nitrite, has announced a split, a bonus and a dividend. It will first offer a dividend of Rs. 10 per share. Then it will split shares into face value of Rs. 2 each (From Rs. 10), then offer a bonus of 1 share for 1.
The share has responded well, going up 5.8% today:
This has followed a steep rise in the last week, on the same news. The results which came out over the weekend were encouraging, but not blowout. The company earned Rs. 36 per share, which is flat from the previous year.
Well, they don’t do anything. The impact of splits and bonuses are simply that the total number of outstanding shares increases.
This changes nothing about the company. Only new shares are issued, or current shares are split. There is no extra profit being made. Therefore the company can’t be valued at any higher number just because it had a bonus or split. Which means that every split and bonus will see the share price FALL just to accomodate the rise in the number of shares.
In this case, Deepak Nitrite’s shares see a 10x increase (1 share becomes 5 for the split, and 5 shares become 10 with the bonus). The price will therefore fall to 1/10th, on the “Ex-Date” which will be announced shortly. (Most likely in July)
The tax impact of splits is different from bonuses. When a share splits, the tax department assumes that the purchase price of each share is also split. That means if you bought Deepak Nitrite for Rs. 415, then a split into 5 shares makes you have a purchase price of Rs. 83 each. The share purchase date is the same as the pre-split purchase date.
In a bonus, the new shares given have a purchase price of zero. But the purchase date for new shares is assumed to be the bonus date. THe date matters only in terms of calculation of long term versus short term gains.
Therefore, in Deepak Nitrite’s case, a single share at Rs. 415 will first see a split and then a bonus. So you’ll have:
The price of the share will drop from the current level of Rs. 560 to 1/10th that, because of the bonus and split, taking it down to Rs. 56. You will not get any more rich because of the bonus or split. If the total number of shares issues goes up 10x, then profit-per-share falls to 1/10th, which means the price has to fall to 1/10th to keep the same P/E.
If you like to see charts, then the share price of Deepak Nitrite will take an abrupt fall on the split or bonus day. This is not desirable, and none of your moving averages or charting indicators will work!
To avoid this the procedure is to divide all pre-split/bonus share prices by 10, so we get an apples to apples comparison. So what looks like Rs. 560 today, will later be adjusted to a smooth Rs. 56 before we chart it.
Fundamentally, while results are decent, there is no sudden reason for this stock to be rerated due to bonuses and splits. But in a euphoric time, every stock goes up and there are reasons “found” after the fact.
At Capital Mind, we’re just happy the stock went up. The reasons are unimportant because the strategy was to buy all-time highs, because stocks that make all time highs tend to keep making them. Of course, we add our little filters of liquidity and analysis alongside, and hope that makes a difference.
The stock was bought because it was making an all time high. It continues to make all time highs. So buying with a 10% stop loss would make sense, however since we are already invested, we won’t buy more. Remember though that this is a season for mad moves. As much as we can rejoice the winners, we must remember to jump off at our stop losses, with no regrets.
For a refresher, here’s the portfolio:
Nothing in this newsletter is financial advice and should not be construed as such. Please do not take trading decisions based solely on the matter above; if you do, it is entirely at your own risk without any liability to Capital Mind. This is educational or informational matter only, and is provided as an opinion.
Disclosure: The authors at Capital Mind have positions in the market and some of them may support or contradict the material given above, or may involve a direction derived from independent analysis.