By Devanesan Evanson
SHARE consolidation and share split are two very common corporate exercises that investors may encounter throughout their investing journey.
Often, we encounter instances where shareholders inadvertently sell off their shares upon seeing a sharp rise in share price, not knowing that the increase was due to a share consolidation exercise.
Investors should be aware of the reason behind the share price movement before they decide to invest/divest a stock.
A sudden rise or decrease in share price may be attributed to a share consolidation or share split exercise which does not affect the aggregate value of their investment.
Investors are strongly advised to peruse the available public announcements to keep abreast of changes in their investees especially when they see a material change in the prices; the announcements may indicate the reasons for the material changes.
Share split and share consolidation exercises
Share split and share consolidation are regulated corporate actions conducted by companies to increase or reduce the number of shares traded on the stock exchange.
Both share consolidation and share split exercises are subject to shareholders’ approval in the form of a special resolution at a general meeting under Section 84 (1) of Company Act 2016.
In a share split, a company divides its number of issued shares by a pre-determined ratio.
For instance, Company X which has 100 shares with a share price of RM10 per share has proposed to divide the number of shares issued on the basis of 1-to-10.
The number of shares it owns post-exercise will increase to 1,000 shares (100 shares x 10) with an adjusted share price of RM1 (RM10 / 10) each. Its market capitalisation will remain unchanged at RM1,000.
Conversely, a share consolidation (reverse share split) works the other way-round by merging the number of issued shares based on a specified ratio.
Assume that a few years later, Company X decides to consolidate the number of shares it owns by 10-for-1. With an existing share price of RM1 and 1,000 issued shares.
The number of shares available in Company X will be reduced to 100 shares (1,000 shares /10) with an adjusted share price of RM10 (RM1 X 10) post-consolidation. Its market capitalisation stays unchanged before and after the exercise.
Ceteris paribus, there should be no capital appreciation before and after the share split/consolidation exercise. As such, neither shareholders’ investment value nor the company’s share capital will change.
Having said that, the asset value and earnings per share will be affected due to the splitting/consolidating effect.
Why does a company split/consolidate its shares?
There are several reasons companies consider carrying out a share split. Firstly, splitting shares increases the number of issued shares circulating in the market. With more shares available in the market, companies hope the trading liquidity of their shares will be improved.
Secondly, the psychological factor may play its part in a share split exercise. As the price of a stock gets higher and higher, some investors especially retail investors may feel the stock is “unaffordable”.
A share split can make shares seemingly more “attractive” and “affordable” to investors (even though the underlying value of the company has not changed).
With more shares in hand, shareholders also feel they have more shares to trade than before. This has the practical effect of increasing liquidity of the stock.
Meanwhile, share consolidation is commonly undertaken by listed entities which have a very large share base and low trading price. A share consolidation will result in a reduction in the number of shares available in the market.
Doing so will probably boost the company’s market perception due to the common stigma attached to a penny stock, or to avoid delisting from stock exchanges, such as New York Stock Exchange and NASDAQ that impose the minimum bid price rule.
If a stock falls below the minimum bid price and remains lower than the threshold over a certain period, it risks being delisted from the exchange.
Moreover, share consolidation is perceived as another alternative for companies to reduce share volatility and speculative trading with a higher share price and lower number of issued shares after the consolidation.
The two sides of the same coin
Since both exercises will have zero effect on the fundamental value of the stock, critics are of the view that these are nothing but creative corporate exercise without any real business proposition.
It is worth noting that legendary value investor Warren Buffett is a firm believer of no-split. The Class A share of Buffett’s flagship investment vehicle Berkshire Hathaway (BRK) has never undergone a share split.
As of Dec 29, 2020, it is the most expensive publicly traded stock in the world with a share price of US$344,820.
By refusing to split the Class A share, Buffett seeks to attract like-minded investors who believe in long term plays with an extended investment horizon. By keeping the price high, it also discourages short-term trading which would increase the stock’s volatility.
Interestingly, Buffett’s BRK Class B shares which are traded at a fraction of the Class A price has the history of share split with a 50-to-1 split back in 2010. While some might argue that this is against Buffett’s no-split stance on Class A shares, this duality is understandable as it avails an affordable version of BRK to average investors.
On the other hand, proponents of share split/consolidation believe that the exercises will bring the share price down/up to a more “attractive” level (despite the zero effect on the fundamental value of the stock), thus enticing the entry of more new investors.
The participation of new investors will then improve the dynamism and vibrancy of the stock.
A stock which was once perceived as “expensive” will be traded at lower price level after share split while a penny stock which was shunned by investors in the past, now looks more enticing in the eyes of investing public after share consolidation.
As the stock is now traded at a more attractive price level after the exercise, they hope the participation of new investors will add to the dynamism and vibrancy of the stock.
However, be aware that share price alone does not necessarily reflect the value of the company.
A higher share price does not necessarily equate to a good stock to hold. Similarly, a low share price could well be an undervalued gem waiting to be discovered. Thus, do not judge a stock by its share price in isolation.
Always remember, the age-old market adage, “Price is what you pay, value is what you get’.
Conclusion
In essence, both share split and share consolidation exercises should have no negative bearing on the part of shareholders. Share split/consolidation increases/decreases the number of shares held by shareholders with every shareholder being equally affected or simply, nobody loses out.
Ceteris paribus, the two exercises should have a net neutral effect on one’s investment. But then again, when has the market ever been rational?
Devanesan Evanson is the CEO of the Minority Shareholders Watch Group, an independent research organisation to encourage good governance among public listed companies with the objective of raising shareholder value over time. He can be reached at [email protected].
The views expressed are solely of the author and do not necessarily reflect those of Focus Malaysia.
