By and large, shares tend to go up in value over the long-term. Over time, this can create a problem for investors wanting a slice of the better-performing companies. To increase the marketability or liquidity of shares, companies implement a share split from time-to-time.
The basic principle of a share split is that the company is cut into more slices. Importantly, shareholders remain holding proportionately the same amount of the company as they did before the split.
Is there a cut-off point as to when shares must be split?
No, there’s no official cut-off point. That said, in the UK it’s quite rare to see companies with a share price in excess of £20.
How about a simple example?
StockSplit plc has 1m shares in issue, and each share is worth £10. A 5:1 share split is declared.
Hold on. What’s this 5:1 business?
That’s the format for how companies refer to the splits. In this case, investors of StockSplit plc will have, after the split, five shares for every one they had before. It’s referred to as a “five for one split”.
There’s no obligation to perform 5:1 splits though. A company could do a 3:1 or 10:1 split, for example.
You may continue…
Thanks. StockSplit plc undergo a 5:1 share split at £10. So, an investor of StockSplit plc having had just one share worth £10 before the split, would have five shares worth £2 after the split.
Here’s the important point. The overall shareholding value hasn’t changed. It still remains at the £10 total.
And do you remember the 1m shares in issue before the split? After the split, there will be 5m StockSplit plc shares in issue. And just as the value of individual investor’s holding won’t change, so the value of the company won’t change either. All that has altered is it has allowed investors to buy the shares in £2 multiples, rather than in £10 multiples. It all makes for a little more liquidity in the StockSplit plc shares.
Surely it can’t be that simple?
No. As with most things within investment, things aren’t as straightforward as they seem. Alongside the ordinary share split described above, there is what’s called a bonus issue. This second type of “issue” is also referred to as a scrip issue. And sometimes it’s called a capitalisation issue too. Again its primary purpose is to aid share-dealing liquidity. But there are differences.
The first difference between this bonus issue and the ordinary share split lies in very technical accounting issues. And very technical they are too. Ordinary private investors have no need for delving into the nitty-gritty of bookkeeping when it comes to bonus issues and share splits. And so that’s that.
There’s also a cunning difference in how the split is described. Within a bonus issue, the term 5:1 means an EXTRA five shares are given as a “bonus” for every one held, and not five shares replacing the original share as we saw with StockSplit plc.
Another example. BonusCo plc have 1m shares in issue, and they trade at £10. They announce a 3 for 1 bonus issue. Or in other words, BonusCo plc investors will receive an extra three “bonus” shares for every one originally held. After the issue, BonusCo investors will therefore have four shares for every one originally held.
So, an investor of BonusCo plc, having had just one share worth £10 before the 3:1 bonus issue, would then have four shares worth £2.50 afterwards. Thus, the 1m of shares in issue will become 4m shares in issue. And as we saw with StockSplit plc, neither the value of an investor’s overall holding, or the value of the company itself, will change because of a bonus issue. All that has altered is that it’s allowed investors to buy BonusCo shares in £2.50 multiples, rather than in £10 multiples.
Does these share splits and bonus issues make any difference to the company at all?
No. Not a jot. Its prospects, profits and assets remain the same as before. The only things that will change are the “per share” values that are reported, such as net asset value per share, earnings per share and dividends per share. Historical records are restated to reflect the additional shares, as the example before and after a 4:1 share split shows below.
Before 4:1 share split
After 4:1 share split
Some people think share splits can be beneficial for share prices. The theory is that the increased marketability of the shares leads to an increase in demand for them. This, in turn, pushes up the share price. There is little evidence for this though.
How will I know a share split has occurred?
The company will make an announcement to the stock market of a split proposal. They will inform shareholders whether it is a bonus issue or a share split. If investors happen to miss the statement, they will usually subsequently find out by an alarming share price “decline” in their portfolio. If, one morning, you see that one of your shares has fallen by 75% or 80%, a share split may well be the reason. Either that or it’s issued a disastrous profit warning!
Can companies do a reverse split?
Yes. When their share price has fallen a lot, some companies will do a reverse split or share consolidation. They may issue 1 new shares for every 20 old shares, for example. This is usually an attempt to restore some credibility, as there is a certain stigma associated with having a share price of just a few pennies. Many companies that saw their share prices tumble in the bear market from 2000 to 2003 have consolidated their shares since then.
One downside of a share consolidation is that the number of shares you hold may not divisible by 20 (or whatever ratio is used). You can’t have part of a share, so the number of new shares you get is usually rounded down to the nearest whole number. The difference, known as a fractional entitlement, is typically sold off for the benefit of the company although, in some circumstances, shareholders may receive the cash payment instead.