Preserving Value: Exploring MRF's Choice to Avoid Stock Split

This report by Bhavya Rathod elucidates how stock price, in isolation, may not convey the true value of the company. The price of one share, among other factors, is also a function of the outstanding shares of the company. When shares’ outstanding are low, and if the demand for that stock is high, the lower supply translates into a higher price for that share. When the price of a share keeps rising, it may reach a level that may become unaffordable to a lot of investors. Therefore, some companies opt for a ‘stock split’ so as to make the shares affordable and reach out to more retail investors

MRF made waves and created history on Dalal Street by becoming the first Indian stock to reach the remarkable milestone of ₹100,000 per share on June 13, 2023. It is worth noting that MRF shares had touched their 52-week low of ₹65,900.05 on the BSE on June 17, 2022. Analysing the stock’s performance over the past decade, it has outperformed the benchmark Sensex index on seven occasions. However, between 2018 and 2021, MRF underperformed the Sensex. In the current year of 2023, MRF shares have shown a positive growth of more than 13 per cent, while the benchmark Sensex has gained over 6.5 per cent. Although MRF has reached the significant ₹100,000 milestone, it is important to highlight the substantial disparity with the second-highest priced stock, namely, Honeywell Automation, which trades at around the level of ₹42,000[EasyDNNnews:PaidContentStart]

“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 nonevent. 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.” 

 This quote reflects Warren Buffett’s belief that stock splits are inconsequential to the underlying value of a company. 

He suggests that investors should focus on the fundamental aspects of the business rather than getting caught up in the optics of a stock split. Meanwhile, Warren Buffet’s Berkshire Hathway Class A shares continues to be the most expensive stock in the world, with the share price trading close to USD 521,000 apiece (approximately ₹4.3 crore). Unless there is a Berkshire Hathaway stock split, the highest-priced stock status will remain with Warren Buffett’s conglomerate. In response, Berkshire introduced cheaper class B shares in 1996, priced at a substantially more affordable price of close to USD 340 per share currently, but has consistently refused to split the company’s original class A offering

Stock price, in isolation, may not convey the true value of the company. The price of one share, among other factors, is also a function of the outstanding shares of the company. When shares’ outstanding are low, and if the demand for that stock is high, the lower supply translates into a higher price for that share. When the price of a share keeps rising, it may reach a level that may become unaffordable to a lot of investors. Therefore, some companies opt for a ‘stock split’ so as to make the shares affordable and reach out to more retail investors.

Investors buying shares in the US stock market are allowed to own fractional shares.

It means one can buy any stock in fractions and keep accumulating it through dollar cost averaging. The US Securities and Exchange Commission allows sub-divisions of securities, and therefore, fractional ownership of stocks makes owning US’ stocks more affordable. Meanwhile, in India, that’s certainly not the case. Here are some of the reasons why a company should consider stock split:

1. Increased Liquidity — A stock split increases the number of outstanding shares, resulting in improved liquidity. With a larger number of shares available for trading, the stock becomes more accessible to a broader range of investors. This increased liquidity can lead to higher trading volumes, narrower bid-ask spreads, and improved price discovery.

2. Enhanced Affordability — By lowering the share price through a stock split, companies can make their shares more affordable to retail investors. A lower price per share can attract new investors who may have been previously deterred by a higher price tag. This broadens the investor base and can potentially increase demand for the stock.

3. Psychological Impact — Stock splits often have a positive psychological impact on investors. A lower share price after a split can create a perception of affordability and value, leading to increased investor confidence and interest in the stock. This can result in positive momentum and potentially attract more buyers, driving the stock price higher.

4. Marketability and Accessibility — A stock split can enhance a company’s marketability and accessibility. It allows the stock to fit within certain price ranges that are favoured by institutional investors, index funds and mutual funds. This can increase the chances of the stock being included in various indices, leading to increased visibility and potential demand from passive investors.

Here are some of the factors why a company shouldn’t consider a stock split:

1. Perceived Lack of Value — A stock split can be viewed as a cosmetic change that does not fundamentally alter the value of the company. Some investors may interpret a stock split as a purely technical manoeuvre, leading to scepticism about its impact on the stock’s true worth. This perception may result in limited long-term price appreciation and potential downward pressure on the stock.

2. Increased Trading Volatility — While a stock split can reduce the price per share, it can also lead to increased trading volatility in the short term. The influx of new investors attracted by the lower price may cause sudden price fluctuations and increased speculative trading activity. This heightened volatility can make it challenging for long-term investors to gauge the stock’s true performance and stability.

3. Lower Perceived Prestige — In certain cases, a high stock price can be viewed as a sign of success, market dominance, or prestige. Implementing a stock split and significantly reducing the share price may diminish the perceived prestige associated with owning the stock. This can potentially affect the company’s brand image and investor perception of its financial strength.

4. Increased Administrative and Transaction Costs — Stock splits entail administrative costs and additional paperwork. Companies need to update their records, issue new stock certificates and ensure compliance with regulatory requirements. Additionally, brokerage firms and investors may face transaction costs associated with buying or selling the increased number of shares resulting from the split.

5. Potential Decrease in Institutional Ownership — Stock splits can lead to a decrease in institutional ownership. Institutional investors, such as mutual funds and pension funds, often have investment policies or restrictions that prevent them from owning stocks below a certain price threshold. A stock split that lowers the share price may cause some institutional investors to sell their positions, resulting in a decline in institutional ownership.

In a bull market, where overall market sentiment is optimistic, and stock prices are generally rising, many stocks tend to experience an upward trajectory. During this phase, market participants, including long-term investors and speculators, may be more inclined to take on greater risk, expecting continued gains. As a result, the focus in a bull market often shifts towards the potential for higher returns and capital appreciation. In this context, stock splits can be seen as a tool to manage the increasing demand and trading activity during a bull market. By splitting the stock and making it more affordable, companies aim to attract a broader range of investors, which includes both retail investors and speculators. This increased participation can contribute to higher liquidity and potentially drive the stock price even higher. 

However, in a bull market, the primary challenge lies in managing the influx of speculative traders who may be solely driven by short-term gains, rather than considering the underlying fundamentals of the company. To illustrate the situation, let’s consider the analogy of a hot air balloon ride. In a bull market, the balloon represents the stock market, and the air inside symbolises the positive market sentiment and the rising stock prices. As the balloon inflates, it lifts higher, signifying the overall upward movement of stocks during a bull market. This rise attracts various passengers who want to enjoy the view from the balloon.

Among these passengers, there are long-term investors and speculators. Long-term investors can be compared to those who appreciate the experience of the balloon ride itself. They are interested in the journey, the scenery, and the long-term prospects. They understand the underlying value of the ride and are willing to stay onboard even when there might be occasional dips or turbulence. On the other hand, speculators can be compared to thrill-seekers who are primarily interested in the rapid ascent and the exhilaration of reaching greater heights. They are driven by short-term gains and may be less concerned about the journey itself. These speculators may inflate the balloon further through their speculative trading activity, amplifying the upward momentum

However, as the market sentiment begins to shift and transitions into a bear market, the situation changes. In a bear market, the overall market sentiment is pessimistic, and stock prices tend to decline or stagnate. During this phase, investors become more cautious, and risk aversion takes precedence over the potential for high returns. In the analogy of the hot air balloon, the bear market represents adverse weather conditions or headwinds that make it challenging for the balloon to ascend further. The air inside the balloon becomes thinner, symbolising the reduced market sentiment and declining stock prices. The thrill-seekers or speculators who were driving the balloon’s ascent in the bull market become less interested in the ride as it loses its momentum. 

Controlling speculators in a bear market becomes a greater challenge for market regulators and company management. Speculators, driven by short-term gains, may look for opportunities to profit from the declining stock prices, often exacerbating the market downturn. Their speculative trading activity can contribute to increased volatility and make it harder for companies and regulators to stabilise the market. In this analogy, imagine the speculators in the bear market as passengers who, upon realising that the balloon is losing altitude, start jumping out to find another thrill ride. Their actions add more weight to the balloon, making it even harder to regain stability and ascend again. 

In the above data, we at DSIJ present a detailed list of 17 such stocks that have crossed the significant threshold of ₹10,000 per share. These stocks not only hold the distinction of being the costliest in the market but also exhibit unique characteristics that set them apart from their peers.

Stock Selection Process — We considered several factors, including stock price, trading volume and valuation metrics, to identify the cream of the crop in terms of high-value stocks. Our objective was to pinpoint stocks that not only boasted high price tags but also possessed additional attributes that make them particularly intriguing for investors.

Trading Activity and Volumes — One notable aspect of these premium stocks is their comparatively low trading volumes. Despite their exorbitant prices, these stocks are traded with significantly less frequency when compared to their peers. This limited trading activity may be attributed to various factors, such as the stocks’ exclusivity, high entry barriers and relatively lower investor participation. Consequently, investors who manage to acquire these stocks become part of a select group, enjoying a level of exclusivity that is often associated with premium investments and thus are not involved in the trading of the stocks on a day-to-day basis. 

Expensive Valuations —In addition to their high price tags and low trading volumes, these stocks also exhibit expensive valuations when compared to their industry peers. This indicates that investors are willing to pay a premium to acquire these stocks, placing a higher value on the unique attributes and potential future returns they offer. The expensive valuations can be justified by the stocks’ exceptional growth prospects, market dominance, or their position as industry leaders. For investors seeking quality and exclusivity, these stocks represent an opportunity to own a piece of the market’s most coveted gems.

To illustrate, let’s consider the valuation of two prominent companies in the market. MRF, known for its premium quality tyres, trades at a valuation of approximately 55. On the other hand, Apollo Tyres, a key player in the same industry, experiences a much lower valuation of around 23. This stark contrast in valuations showcases the differing perceptions of investors towards these companies, with MRF commanding a higher premium. Another example can be observed in the FMCG sector. Nestle, a renowned multinational food and beverage company, currently trades at a staggering price-toearnings (PE) ratio of 86. In comparison, Britannia Industries, a well-established player in the same sector, trades at a valuation close to 60. 

Although Britannia’s valuation is still considerably high, it is notably lower than that of Nestle, emphasising the varying levels of investor optimism for these two industry giants. These valuation discrepancies can be attributed to several factors such as brand reputation, market dominance, growth potential and financial performance. Investors are willing to pay a premium for companies that exhibit strong growth prospects, industry leadership and a track record of delivering consistent returns. Meanwhile, companies with relatively lower valuations may be perceived as having room for growth or facing certain challenges that impact their market appeal.

Investor Sentiment — The fact that investors are willing to pay a premium for these stocks is a testament to their confidence in the future prospects of the underlying businesses. It reflects a belief that the premium price is justified by the stocks’ potential to deliver substantial returns over time. By investing in these stocks, investors position themselves as early adopters and beneficiaries of the anticipated growth and success of these high-value companies.
 

Conclusion

While stock splits can be effective in managing trading activity and attracting a diverse set of investors during a bull market, controlling speculators in a bear market becomes a greater challenge. The analogy of the hot air balloon ride highlights how the behaviour of speculators can impact market dynamics and exacerbate the downward movement in a bear market. Regulators and company management face the task of implementing measures to mitigate excessive speculation and stabilise the market during such periods of market downturns. In a letter to shareholders back in 1983, Warren Buffett shared an intriguing perspective on stock splits.

“Were we to split the stock or take other actions focusing on stock price rather than business value, we would attract an entering class of buyers inferior to the exiting class of sellers. Those who think so and who would buy the stock because of the split or in anticipation of one would definitely downgrade the quality of our present shareholder group,” he stated. For investors, it is crucial to understand the motivations behind a company’s decision regarding stock splits or bonus issues, and to assess whether these actions align with one’s investment objectives and risk tolerance. By analysing the strategic choices of companies like MRF and Nestle, investors can gain valuable insights into the diverse approaches taken by businesses in managing their stock prices and attracting investors.

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