STOCK SPLITS

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A stock split is a corporate action in which a company's existing shares are divided into multiple shares. For example, in a 10-to-1 split, each stockholder receives 9 additional shares for each share he holds or you can multiply the number of shares he has now by 10 in order to find out the total amount of shares he will have after the split.

Unlike an issuance of new shares, a stock split does not dilute the ownership interests of existing shareholders.

If the company pays a dividend, your dividends paid per share will also fall proportionately.

Reasons for Stock Splits

Market Psychology:  As the price of a stock gets higher and higher, some investors may feel the price is too high for them to buy, or small investors may feel it is unaffordable. Splitting the stock brings the share price down to a more "attractive" level. The effect here is purely psychological. The actual value of the stock doesn't change one bit, but the lower stock price may affect the way the stock is perceived and therefore entice new investors. Though Buffett’s Berkshire Hathaway has been known to be not in favour of splits with a single share now trading at $120,280

Increase A Stock's Liquidity: There are more buyers and sellers for 10 shares at Kshs. 10 than for 1 share at Kshs. 100. Liquidity increases with the stock's number of outstanding shares. 

By splitting shares, a lower bid/ask spread is often achieved, thereby increasing liquidity. Splitting the stock also gives existing shareholders the feeling that they suddenly have more shares than they did before, and of course, if the price rises, they have more stock to trade.

Stock splits have absolutely no effect on the net worth of a company. The market capitalization of the company is not altered and therefore no dilution occurs.

Example

 FGH Company has 1000 shares priced at Kshs. 100 per share. The market capitalization is 1000 × 100 = Kshs. 100,000. The company splits its shares 2-to-1. There are now 2000 shares of stock and each shareholder holds twice as many shares. The price of each share is adjusted to Kshs. 50. The market capitalization is 2000 × 50 = Kshs. 100,000, the same as before the split.

A split therefore doesn’t change any of the business fundamentals. In the end, whether you have a Kshs. 1000 note or two Kshs. 500 notes, the money that you have is the same.

Split adjusted share price

If a company has undergone stock splits comparing historical stock prices to those of the present day would not accurately reflect performance. All the closing prices before the split will be taken and divided by the split ratio. If a stock is trading at Kshs. 64 and it splits 4-to-1, the after-split price will be Kshs. 16

Reverse Split

This procedure is typically used by companies with low share prices that would like to increase these prices to either gain more respectability in the market or to prevent the company from being delisted. 

For example, in a reverse 10-to-1 split, 40 billion outstanding shares at Kshs. 5 each would now become 4 billion shares outstanding at Kshs. 50 per share. In both cases, the company is worth Kshs. 200 billion. For every ten shares you own, you get one share.

Dividend (Re)Investing

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Dividend reinvestment is a systematic method of accumulating shares of a company that pays a dividend. Some investors use dividend reinvestment as part of a long term buy and hold investment program.

The main advantage of reinvesting your dividends is that you are able to make use of the power of compounding in your favor. By using the dividend income to purchase more shares, an investor is able to accumulate more shares of a company.

Another reason for reinvesting dividends is that one could cost average their dividend income into more shares by spreading their purchases over a period of time, which also decreases risk.

Important terms related to dividends

Dividend Yield

It is calculated by dividing the Dividends per Share with the Share Price. Income investors will tend to go for stocks with high dividend yields.

But a high dividend yield may also indicate a depressed price.

The important indication of dividend power is not so much a high dividend yield but high company quality, which you can discover through its history of dividends, which should increase over time.

Dividend payout

This is the percentage of earnings paid to shareholders in dividends. This is calculated by dividing the Dividends per Share by the Earnings per Share

More mature companies tend to have a higher payout ratio. Meanwhile growth companies tend to have lower dividend payouts as the management believes that shareholders will be able to achieve greater returns if the majority of the company’s earnings are ploughed back into the business.

Management decides what percentage of earnings will be paid out to shareholders, and then puts the remaining profits back into the company.

 Dividend Trap

A company may have an inviting dividend yield but the business might be on its way down. Is the company expected to maintain the Dividends Per Share for the next financial period? An investor should analyse the other fundamentals of the company

Since dividends are paid from cash, the company should have some previous consistency of earnings growth. The company should not recently have taken out a huge debt which would bring cash flow problems to the business.

In conclusion, investors should know that reinvesting dividends provides a tremendous opportunity for growth of wealth over time.

THE POWER OF COMPOUND INTEREST

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This is the first of several articles I will be posting on my blog touching on personal finance.

Compound interest can be explained simply as earning interest income on interest income, resulting in your money growing at an ever accelerating rate.

Similarly, it can be termed the concept of adding accumulated interest back to the initial investment, which is known as the principal. Doing this means that interest is earned on previously accumulated interest. Therefore when we add the interest back to the principal (making it a part of the principal), it is what is known as compounding.

Albert Einstein once noted that the most powerful force in the universe was the principle of compounding. That was a pretty smart guy there! I wouldn’t argue with him.

How to begin benefiting from the power of compound interest

Start by saving a certain amount of cash every month. Yep, you have to spend considerably less than you earn. 

Put it into an investment that gives affair return at not too high a risk e.g. Some bonds in Kenya currently give 12%.

Don't take it out except to invest in better interest-bearing investments. You might also consider adding additional money as and when it becomes available.

Start saving today. 

Things That Determine Your Compound Interest Returns

Start early: The amount of capital you start with is not nearly as important as getting started early. Every year you put off investing makes your ultimate goals more difficult to achieve. Even modest returns can generate huge amounts given enough time and dedication. The younger you start, the more time compounding has to work in your favor, and the wealthier you can become. Time is the primary ingredient to the magic that is compounding. Do not look to get rich quick

Make regular investments: Remain disciplined and make saving a requirement.

Be patient: Do not touch the money. Compounding only works if you allow your investment to grow.

Rate of return: Don’t put your money in a bank account which would only give you a 2-3% return. You are better off putting the money in bonds earning higher interest and which offer almost no risk.

 Compound Interest Table - The Value of Ksh. 10,000 Invested In a Lump Sum

	4%	8%	12%	16%
10 Years	Ksh. 14,802	Ksh. 21,589	Ksh. 31,058	Ksh. 44,114
20 Years	Ksh. 21,911	Ksh. 46,610	Ksh. 96,463	Ksh. 194,608
30 Years	Ksh. 32,434	Ksh. 100,627	Ksh. 299,600	Ksh. 858,500
40 Years	Ksh. 48,010	Ksh. 217,245	Ksh. 930,510	Ksh. 3,787,212
50 Years	Ksh. 71,067	Ksh. 469,016	Ksh. 2,890,022	Ksh. 16,707,038

The formula for getting the end amount of a sum subjected to compound interest is: P(1+r)^ⁿ

Where P = Principal, r= rate of return you are expecting (in % terms), and n = number of years of investment

If the rate is being compounded more than once a year, then the following formula can be used: P(1+r/t)^^nt

Where t = amount of times the interest is compounded in a year. If semi-annual, then t = 2, if quarterly, then t = 4, e.t.c

The above table is just a simple example of lump sum investing. I also used a very low figure of Ksh. 10,000. Imagine what you would accumulate if you made a habit of saving and investing a figure more than the Ksh. 10,000 above? By adding onto the principle every year, the results would be great.

Now, what are you waiting for? Put it to work! And don’t forget to tell your kids about it too.