DO EVENTS TRIGGER ABNORMAL RETURNS?

Bonus and splits are not uncommon in India; on an average 100 companies declare either bonus or share split every year. Under either situation one common objective of the company is to decrease the prevailing share price and increase the liquidity; when shares are concentrated it can create problems in decision-making and higher liquidity of shares would obviously lead to higher trading volumes and more marketability. For an individual investor it becomes difficult to purchase shares when the share price of a company is extremely high and companies in such cases do declare bonus or split to get shares in the preferred trading range. Though technically there is no standard definition of what should be the preferred range, some researchers have identified that the desirable price should be below Rs 500.

Recently two prominent companies in India declared bonus and split. Let’s understand the two events before we understand what’s hidden for us in the headlines. ICICI declared stock split of 5:1 (on November 21, 2014) when the price of the share was about Rs 1,700. The face value of Rs 10 was replaced with five shares of face value of Rs 2 each after the ex-date (December 5) the share was trading at about Rs 362. After the split the share is trading within the desirable trading range and has more liquidity.

Infosys declared bonus of 1:1 on October 10, 2014 when the share price was about Rs 3,600 with face value of Rs 5. After the ex-date of December 3 the share was trading at about Rs 2,100. Though the share price is not within the preferred trading range, it is more attractive to the individual shareholder as the price has decreased. SEBI has allowed the minimum face value to be Rs 1 and companies whose face value is above the minimum face value can declare share split, but if the face value is Rs 1 then the only way to increase liquidity and decrease the price is to declare bonus shares.

Over years bonus and splits have been declared by the board to increase liquidity and keep the share price in the affordable range but the event has a signalling effect, though fundamentally nothing changes overnight. Typically if we assume that the news relating to the event is made public 30 days in advance and if we capture the price movement in this period for all the companies we can analyse how the market reacts to the news. Hence we make a portfolio of all shares which have declared either bonus or splits to capture the market reaction and the results are very astonishing.

We examined all the companies listed on the BSE which declared bonus and split from 2001 and data of 30 days pre-bonus or splits was downloaded from the database of Capitaline. Our total sample consists of 719 companies declaring split and 522 companies declaring bonus. Up to 90 per cent of the companies declaring bonus were in the ‘A’ and ‘B’ category of the BSE and the average price after bonus in ‘A’ category stocks was Rs 298 and in category ‘B’ it was Rs 110; this clearly indicates the preference of the board to keep the prices low. Almost 50 per cent companies declared bonus in the ratio of 1:1. Around 76 per cent of the companies which declared splits were in the ‘A’ and ‘B’ category and the average price of shares in the ‘A’ category after split was Rs 242 and in Category ‘B’ was Rs 100. Again, the motive seems to be the preference of keeping the price of share below the desirable range.

The portfolio was constructed 30 trading days prior to the event date and it was liquidated on the event date. The simple return was calculated for each stock during the 30-day period; the return would indicate how markets react to the news of bonus and splits. The findings are suggestive of the fact that for 68 per cent of the companies declaring bonus the price was higher as compared to the price 30 days before the event date and for companies declaring splits the prices were higher for 63 per cent companies. The average returns within the 30-day window were around 14 per cent for bonus and 9.5 per cent for splits. If the returns are annualized (assuming 250 working days) the returns would be 116 per cent for bonus and 79 per cent for splits. This clearly indicates that the market reacts more favourably to the news of bonus shares in comparison to stock splits and if the objective of the management is to reward the shareholder and increase liquidity (and they have the option of using either bonus or splits) then bonus should be used.

If we look at the second objective of increasing the liquidity by declaring either bonus or split  and compare the average volume 30 days before and after the event, the findings suggest that average volume increases for 20 per cent (37 per cent) of companies which declare bonus (split); these findings suggest that the objective of increase in volume is achieved for a few companies. We went a step further to explore if the returns are permanent or a temporary increase which would fade over time and hence we calculated returns on the bases of prices prevailing 30 trading days after the event.

The finding suggests that even after 30 days from the event date, the average annualized returns for bonus and splits are approximately 88 per cent. For 53 per cent the company’s average price 30 days after the event was higher than 30 days before the event. These findings are suggestive about there being a fall in prices after the ex-date but the appreciation in price does not bottom out completely and for either of the events the market reactions are positive. Data analysed (May 2015) of over 4,000 listed companies indicates that over 300 companies are trading above Rs 500 and 81 per cent of the companies  have face value of Rs 10. This indicates great scope for bonus or splits in the future.

For an individual investor who believes in trading, there is a great opportunity by simply investing in all stocks which declare either bonus or split and liquidate the position on the ex-date. For long-term investors these two events are a permanent wealth creation opportunity and they should hold the stock for a longer period.