Splits misused to destroy small investors money

Updated: Nov 17 2005, 05:30am hrs
The current share prices of the three IT majorsInfosys, TCS and Wiproare Rs 2,720, Rs 1,507 and Rs 408, respectively. Obvious conclusionin absolute terms, Infosys is the highest priced. But the reality is different. The face value of these three companies is Rs 5, Re 1 and Rs 2, respectively. So, if one wants to do a correct comparison, the prices would work out to Rs 5,440, Rs 15,070 and Rs 2,040, respectively, making TCS the highest priced.

Prices by themselves are meaningless, as the true barometer is the price- earnings ratio. But, unfortunately for most investors, the key indicator is the price. Differing face values accentuate the confusion. Years ago, to avoid confusion, Sebi had mandated all companies to bring their face value to Rs 10 (many had it at Rs 100).

Remember the Maruti IPO in 2003 It had planned to sell its shares at Rs 230 each. Pre-issue marketing exercise revealed no takers. Then wisdom dawned. Face value was split from Rs 10 to Rs 5, primarily to make the share look cheap at Rs 115. The issue sold. In another instance, a company finding Rs 50 too high, split by 1:5, thus pricing at Rs 10 per share (Rs 2 face value, plus premium Rs 8). The issue sold, with many investors believing that since the issue was at Rs 10, it was at par value (par is always considered cheap!).

The author had made a strong presentation to Sebi and had persuaded it to finally issue guidelines, in May 2004, prohibiting companies from undertaking share splits before their IPOs if the share price was below Rs 500. To curb the emerging malpractice by listed companies, a Sebi committee had then proposed that split here, too, should be allowed only if the market price is above Rs 500. Implementation has, however, hit a roadblock.

In the absence of any regulation, there is an increasing abuse of this facility. In 2005, a record 125 companies have done share splits. In 2004 and 2003, only about 30 companies each had done so. Worse, the face values are now being changed to absurd levelsRe 1, Rs 2, Rs 5 and even Rs 4.

Sebi prohibited share splits before IPOs if the share price was below Rs 500
In the absence of implementation, 125 firms went in for share splits in 2005
The concept of face value, now changed, should be done away with
Why should a company want to split A split does not help it in any manner. The argument forwarded is that it infuses additional liquidity by making the shares more affordable. For whom Surely not the existing shareholders. In reality, it has become a device to lure new investors.

Small investors typically go for shares priced low in absolute terms, as these appear to offer scope for appreciation. But that is just a mirage. It makes no difference whether you buy one share for Rs 300 or two shares for Rs 150 each.

In a demat environment, split becomes meaninglessone can buy just one share of a company. Moreover, the availability of a larger number of shares alone cannot attract a larger investor interest.

No doubt, there have been some blue-chip companies with very high share prices, where a split did make sense. However, the worrisome factor has been dozens of penny-stock companies. Where is the logic of splitting a share when the market price is, say, only Rs 20, or even Rs 100 Obviously, to make money, not for, but off the small investors. The promoter-operator nexus would first rig the price from, say, Rs 10 to Rs 100. The company would be noticed, but many small investors may not bite in, because of the high price. The stock would then be split, for example, by five times. A share price of Rs 20, which also now does not appear to be manipulated, becomes cheap and starts attracting the retail. The price is rigged up a second time. The cartel then sells out, for huge profits. In this way, a split also becomes handy for liquidating promoters holdings of an otherwise highly illiquid share.

We need to revisit this subject. In fact, the time has come to do away with the face value concept itself. It also has a big inherent danger; since discount on face value is not allowed, many companies have made IPOs at par (Rs 10), when the real worth of their share was only Re 1 or Rs 2; the law, therefore, allowing an implicit premium.

The writer is the managing director of PRIME Database