V Pattabhi Ram and A V Vedpuriswar
“Hey, that’s sexy” cooed Wafers. China was reminded of his “ragging” days at IIT. A senior had asked him to define sexy. China had blanched. And was promptly pulled up for having a dirty mind. Someone explained, “It is ‘1/Cos C’ my dear.” China almost puked.
“Look WIPRO has announced a 1:1 bonus” said Wafers. “So what’s sexy about it?” asked China. “You see, for every one share held I get one free. I have 50 shares; I will now have 100” she said. That statement took Rinku’s breath away. He worked for a pink paper and was shocked that someone doing her CA final could lay such an egg.
“Hey, the 50 shares aren’t free money” he said. “I know” cracked Wafers. How could she forget. Her professor had once famously explained why bonus does not increase wealth. He had said, “A bonus cannot create wealth. All that happens is that reserves are transferred to equity account. If wealth can be created by an accounting entry then companies do not have to produce goods and sell them. They just have to engage accountants to keep capitalizing Reserves!”
“Okay, tell us what is it that you know?” Rinku asked Wafers. Wafers was hurt, but she didn’t show it. “A bonus issue doesn’t change the wealth of the firm. With the numerator (market capitalization) remaining unchanged and the denominator (number of shares) going up, the price per share will fall. Theoretically a 1:1 bonus would bring share price down by half”. China chimed, “You mean what you gain on the old share you lose on the new.” Bravo.
“That being so why would anyone be excited by a bonus” wondered China. Wafers was thrilled at the prospects of carrying coal to Newcastle. “See, there are many reasons. Like, the share price falls and brings it within the comfort zone of the investor”. Rinku chipped in. “She means that an investor is happier buying two shares at 360 each than one share at 720. Right?”
Wafers’ professor had called the phenomena mental accounting. He had narrated a story. “Jeanne had gone to a casino in Katmandu and had staked Rs 100/-. She won Rs 200. She then staked the Rs 200 as well and saw it double. She kept winning until she had won Rs 5,00,000. Then the tide turned and in one shot she lost it all.” The professor had asked, “How much did Jeanne lose?” The class roared “Rs 100”. The professor had sworn that they would make great accountants. “The accountant thinks he has lost Rs 100 because that’s the money he would debit the gambling account!”
Somebody had hissed, “The economist would know that Jeanne had lost Rs 500,000”. While agreeing with it, the professor had tongue firmly in cheek remarked, “An economist is one who when he sees a Rs 100 note on the road says that this cannot be a Rs 100 note because if it had been one someone would have picked it up.” The class had roared in approval.
China asked, “Price fall apart, what else is it about bonus that would excite an investor Wafers explained. “When the share price falls, investors move in to buy shares. They read a positive signal in the bonus. A company would not declare bonus unless they are sure of servicing it in the future. So the demand for shares goes up and the price too goes up.” China echoed, “The law of demand and supply in operation.” Right.
“Hey, that’s sexy” cooed Wafers a second time. “Look ITC has announced a 10:1 stock split in addition to a 1:2 bonus” she said. “So what’s sexy about it” asked China. “You see for every two shares that I hold I get one share free. And then these three Rs 10 shares are taken away from me and I get 30 shares of Re 1 each. So from holding 2 shares I now hold 30. It was now China’s turn to be stunned. “Now doesn’t the stock split look frighteningly similar to that of a bonus?” he asked.
“Yup”, said Wafers. “But there is a difference. In accounting speak, we don’t have to transfer money from reserves account to equity account” she purred. This time around she was glad carrying lignite to Neyveli! China remarked, “From what you said, the Rs 1800 share will start quoting around Rs 120.” [(1800X2)/30]. Wafers wasn’t surprised. China wouldn’t be China if he wasn’t that quick on the uptake. “Yeah, you are right” she said. “And for the same reasons that I explained in the case of bonus, demand will begin to build and the price will climb up.”
Rinku stepped in. “See bonus and stock split can actually work the other way too. In the case of ITC, an investor having 100 shares would as per your computations now have 1500 shares. He could step in to sell some. As pressure builds up and supply outstrips demand prices could actually fall.” China said, “So all bonuses and all splits aren’t necessarily good.” Wafers agreed. In the end, it depends on what the market perceives. “Yes, the price could go up or it could come down.”
China complimented Wafers for speaking like a true analyst! He remembered an analyst who when once asked by a scribe as to which way the market was headed in the short term had said, “The market might either go up or might come down!” Bravo. The journalist had then rubbed in. “Mr. Analyst the market could also move sideways”. A distinct touché indeed. Or was it a PJ (poor joke in IIT lingo?)
“So economics apart, it is all a mind game”, said Wafers unmindful of the jibe.