With the stock markets reaching dizzying heights, stock prices of many top companies have become unaffordable for many small investors. In such a situation, these investors have just 2 options: either wait for the markets to crash, which can be a very long wait or buy when a company goes for a stock split.
What is a stock split? How does it benefit small investors? In a stock split, the total number of free shares of the company is divided into bigger number of shares, without impacting the shareholder’s equity or the stock’s overall market value. E.g. if the company announces 5-to1 stock split, it means that for one share of the company that each shareholder holds, he now gets 5 shares. He doesn’t have to pay anything to avail of these 5 shares.
Also the market value of the share will be divided by 5. E.g. if the market price of the share is Rs 1000, the new market price of the share now becomes Rs 200. Moreover the company’s market capitalization now becomes 5 times it original market capitalization. The company can achieve this without diluting its equity.
Normally companies take this step if they think that the price of their share has gone so high that many small investors are reluctant to pay the price. With this step, the company brings the stock price within the reach of ordinary investors. HDFC took this step some time back.
An investor gains by buying the shares of good companies at low prices, as stock split doesn’t affect the company’s performance. However it is important not to get swayed by the stock split when making investment decisions. Instead it is crucial to focus on company performance, management reputation, company’s growth prospects, future plans and its position vis-à-vis its competitors.
Manish was advised by his mutual fund advisor to invest in a mutual fund that had just announced a dividend of 10%. Accordingly, Manish invested in the fund only to find that the value of the fund had decreased. Manish was shocked with this development as he considered the dividend from the mutual fund same as that of the dividend from the stock.
Manish is not alone. There are many such gullible investors who are taken for a ride by unscrupulous financial advisors. Also sheer ignorance makes people think dividends from mutual funds are the same as the dividends from stocks. But this is not true. Here are the differences between both of them.
When a company declares a dividend, it does so from its income. But when a mutual fund declares a dividend, it does so from the capital appreciation of its NAV. Now the money with the mutual fund is your money as the fund’s job is to collect money from multiple investors and invest in different companies on your behalf. When the share prices of the underlying companies go up, it will push up the NAV of the find, which the fund will then give as a dividend.
The share price of the company is decided by the market and not by the dividend. But in case of a mutual fund, the NAV of the fund decreases by the value of the dividend declared. E.g if the NAV of the fund is Rs. 20 and the fund declares a dividend of Rs 4, the NAV of the fund after the dividend would be Rs. 16.
Also unlike shares, opting for dividend will help in growth of your investment. Hence if you are looking to save for any long-term goal like retirement or children’s education, go for the growth option. So next time your mutual fund broker advises you to invest in a mutual fund just because it is giving a dividend, ignore it.