Don't Let This Corporate Action Fool You

Thu, 29 Sep Pre-Open

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Corporate actions like dividends, bonuses, stock splits etc. are closely watched by all the analysts and investors alike. According to a Business standard report, in the current financial year, about 45 companies have already announced their stock split.

In simple words, a stock split is when a company announces an increase its number of shares outstanding by issuing more shares to its existing shareholders. Such actions by the company increases the number of shares outstanding thus effectively reducing the price of each share. The overall market capitalization of the shares however, remains the same. The rationale behind such sub-division is primarily to improve liquidity and affordability among the general public.

Corporate actions like a bonus or a stock split in the form of sub-division in the the face value are looked upon favorably by the retail public. Is it okay to buy the stock only if the price falls only due to splits without any change in fundamentals? These stock splits usually happen in a bull market, interestingly some managements perceive that giving out bonuses and splits is just another way of creating wealth in the hands of the shareholders.

We think that the people wrongly anchor themselves on the price per share metric. While price of a share is important, however the most important metric that must be noted is the underlying fundamentals. A stock must not be viewed as a ticker symbol with a number, it must be understood that there is an underlying business that drives the company. It is of utmost importance that one understands how this business functions.

Bonuses and splits provide the speculators and those with a short time horizon with some market action. Note that the stock split has no fundamental effect on a company or its valuations, one must not base his decision on the basis of these corporate actions. However, in the long run, it is the drive towards fundamentals that decides the value of the stock. What really creates wealth for the shareholders are not bonuses and splits, per se. Improving fundamentals is what matters in the end. Fundamentals factors like the growth prospects of the company, management quality, business model, etc. should continue to remain the deciding factors while making an investment decision.

The father of value investing, Benjamin Graham knew this fickle crowd behavior all too well, in the long run he also believed, it is the fundamentals that count.

"In the short run, the market is a voting machine but in the long run, it is a weighing machine."

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