Of Stock-splits and Bonuses

Stock splits are a farce in India.

In fact the capital markets have a fundamental flaw in the model. The face value should have been Rs.1/- ... instead, they had started with Rs.1000 and Rs.100 in the 1950s ... and later moved to 10.. then 5,2,1... who knows, maybe even 50 paise in future!! Ridiculous.

Stock splits serve no purpose other than increasing the pathetic liquid stocks in floating, by a small margin.... it still is nowhere near where it should be... but something is better than nothing.

And people have the dirty habit of punting on stock split as an event. In investment terms, the existing sharholder does not see reserves and surplus being redistributed to him. Stock split is nothing but hair split. No value to anyone other than the promotor sharks and the big broker sharks, who can happily punt, and make even more money.

Floating stocks in some of the scrips is pathetic... slightly more than 10% of paid up capital... It is high time we made amendments to the Companies Act 1956, by making the face value of stocks uniform, and make a mandatory 50% liquidity in the market. With 10% liquidity, the promotors and the big borkers can easily manipulate the market, which is what is happening today.

As for Bonus, it is slightly better than stock splits - but not by much.
Technically, bonus shares are a way to redistribute the Reserves and Surplus of the company, after providing for all liabilities ( in other words, giving back some of the profits of the company to the shareholders, after all debtors are taken care of). But again think of this - if you are a long term investor, ie, a real shareholder running a company, would you rather prefer the money to work for bettering the company prospects, or would yo prefer to punt?

A classic case of this is Warren Buffet's Berkshire Hathway. Buffet has refused to give bonus or splits since the company was formed in the 1950s. Every dollar worth of those shares was selling at $100,000 apiece, until a few years ago, when he was forced to split, due to per-share price shooting over a 100000, making it unaffordable for many commoners.

I found Tata Power splitting from 1000, to 10 stocks of 100 each... I laughed at it. What the hell is the difference between buying and holding 1 stock of Rs.1000, vs holding 10 stocks of Rs.100? Unless one is saying " I buy only 5 stocks at a time".

These gimmicks are supposedly to help grow the small investor community, but the real beneficiaries are the sharks.

The other issue is how the splits and bonus are treated for taxes. Splits carry no implications. But bonus has tax implications.

If you buy a stock for 500 stocks for 200 rupees today, and it gives a 1:1 bonus, then ex-bonus, you will have 1000 stocks ( at ideally Rs100, but manipulations will ensure that it gets to 150 in no time, and then crash back to 75 apiece). Now, the original 500 can be sold at 500*100... booking a short term loss ( if holding for less than a year). In the eyes of the taxman, the cost of acquisition of the 500 bonus shares is zero. So, if you sell right after ex-bonus, you attract huge ST Capital gains on those 500 bonus shares. If you hold them, and sell after one year, you pay zero. The short term loss that you may have booked, can be set off against any short term capital gains in that FY.

So, the smartest way to play bonus is to buy ahead of the bonus, and sell the original shares within a year, and then hold on to the bonus for more than a year, and avoid taxes completely.

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