In the ever-evolving world of finance and investments, stock price is often the first thing that catches the eye of investors. A soaring stock price can create a sense of excitement, and sometimes, a touch of envy. It’s the metric that graces newspaper headlines, trends on social media, and fuels conversations at cocktail parties.
But is a high stock price always an indicator of a company’s true value? The answer, as it turns out, is not that simple.
Enter MRF, the Indian tyre giant that recently etched its name into the annals of stock market history. On June 13, 2023, MRF’s stock price soared to a staggering Rs 1,00,000 per share, making it the first Indian company to breach this remarkable milestone. Just a year prior, MRF shares languished at their 52-week low of Rs 79,101.05 on the Bombay Stock Exchange. The journey of this tyre titan exemplifies the complex nature of stock prices and investor sentiment.
A Decade of Performance
To understand the significance of MRF’s achievement, let’s delve into its stock performance over the past decade. It’s a tale of triumphs and occasional stumbles. MRF outperformed the benchmark Sensex index on seven occasions, demonstrating its mettle as a market leader. However, between 2018 and 2021, the company faced headwinds, underperforming the Sensex.
In the current year of 2023, MRF shares have surged by more than 21.65%, while the benchmark Nifty50 has gained a respectable 7.83%. It’s evident that MRF is no stranger to market fluctuations, and its latest ascent to the Rs 1,00,000 club raises an intriguing question: why does the company shun stock splits?
The Oracle’s Wisdom
Warren Buffett, the Oracle of Omaha and one of the most revered investors of our time, once remarked, “I have never recommended a stock split. If you are going to buy the stock, it doesn’t bother you whether they split it or not. It’s just such a non-event. It’s like saying I have got a car that goes 100 miles per hour. So what? If you are not going to drive 100 miles per hour, you don’t need the car.” These words reflect Buffett’s belief that stock splits are inconsequential to a company’s underlying value.
In fact, Warren Buffett’s Berkshire Hathaway boasts the world’s most expensive stock, with shares trading at close to USD 527,960 apiece (approximately Rs 4.4 crore). Despite this stratospheric price, Berkshire Hathaway has steadfastly resisted the temptation to split its Class A shares. Instead, it introduced more affordable Class B shares in 1996, currently priced around USD 348 per share. This move illustrates the Berkshire Hathaway philosophy of prioritizing substance over optics.
To Split or Not to Split?
The decision to split or not to split a stock is not to be taken lightly. It’s a strategic move that can have far-reaching consequences for a company and its investors. Let’s explore the rationale behind both sides of this debate.
Why a company should consider stock split?
- Increased Liquidity: Stock splits result in more outstanding shares, enhancing liquidity. This increased supply can attract a broader range of investors, leading to higher trading volumes, narrower bid-ask spreads, and improved price discovery.
- Enhanced Affordability: Lowering the share price through a stock split makes shares more accessible to retail investors. This can broaden the investor base and potentially increase demand for the stock.
- Psychological Impact: Stock splits often have a positive psychological impact, creating a perception of affordability and value. This can boost investor confidence and interest in the stock, driving the price higher.
- Marketability and Accessibility: Stock splits can make a company’s stock more attractive to institutional investors, index funds, and mutual funds, increasing visibility and potential demand from passive investors.
Why a company shouldn’t consider stock split?
- Perceived Lack of Value: Stock splits can be seen as cosmetic changes that don’t alter a company’s fundamental value. Some investors may view them sceptically, potentially limiting long-term price appreciation.
- 2. Increased Volatility: Stock splits can lead to short-term volatility as new investors enter the market. This can make it challenging for long-term investors to gauge the stock’s performance.
- Lower Prestige: In some cases, a high stock price is a symbol of success and prestige. A stock split may diminish this perception and affect the company’s brand image.
- Administrative and Transaction Costs: Stock splits entail administrative and transaction costs, which can be burdensome for companies and investors.
- Decrease in Institutional Ownership: Stock splits may lead to a decrease in institutional ownership, as some institutions have restrictions on owning stocks below a certain price threshold.
Navigating a bull market
In a bull market, where optimism prevails, stock splits can be a tool to manage increasing demand. They make shares more affordable, attracting a broader range of investors. However, the challenge lies in managing speculators who may prioritize short-term gains over fundamentals.
Imagine a hot air balloon representing the stock market in a bull market. Long-term investors enjoy the journey, while speculators seek rapid ascent. Speculators can inflate the balloon further, amplifying upward momentum.
The Bear’s Shadow
In a bear market, the landscape changes. Speculators exit, and the challenge becomes controlling their actions, which can exacerbate market downturns. Speculators act as weights on the balloon, making it harder to regain stability.
As the analogy goes, the bear market represents adverse weather conditions, and speculators are passengers looking for the next thrill ride.
MRF’s decision to shun stock splits isn’t a mere financial choice; it’s a strategic one that aligns with Warren Buffett’s belief in focusing on fundamentals over optics. It’s a reminder to investors that the true value of a company isn’t solely reflected in its stock price.
Whether a company chooses to split its stock or not, investors should always delve deeper, understand the fundamentals, and be prepared for the ride, regardless of whether it’s a bull or bear market. After all, in the world of investing, it’s the journey, not just the price, that matters most.
Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.