Q&A with CMMB Securities

Q: What is the meaning of a stock split?

Jerry, Maraval

A: A stock split, as the name implies, is when a share is split in a certain ratio. For example, a 2 for 1 stock split means that for each unit of a share before the split there are now two units after the split. In this example, every stockholder owns twice the number of shares in the firm after the split, but each unit of stock is worth proportionately less, ie half of the original price. However, since the number of units held is twice that held originally, the dollar value of each shareholder’s holding remains unchanged. So just after the split the value of shareholder wealth remains the same although the number of shares in issue has doubled. The benefit of doing this, from the company’s point of view, is to increase the market of possible shareholders. As the price of a share falls, it immediately becomes affordable to a wider group of people.

It may ultimately result in a wider distribution of holdings. This may then eventually increase the frequency of trading and the price efficiency of the share (how quickly the price of the share reacts to information about the company). However, experience has shown that a stock price rises on the announcement of a stock split. This is because of the interpretation investors have about the meaning of a stock split. It is argued that firms will only split their stock if they believe their stock price will keep rising, or feel they can increase their dividends in future periods on a larger number of shares. In fact, on the local stock exchange there have been cases where shares have been split and the price after the split eventually increased back up the pre-split prices thus generating significant returns for investors. Talk to your broker to get advice on which shares look likely to split.

Q. Can you explain why high liquidity is bad for the economy? I would have thought it’s a good thing as ordinary people can get loans. 

Kelvin, San Fernando  

A: Liquidity in an economy must be maintained at a level that does not result in high inflation or at levels that would result in an overheated economy. The level of liquidity in the system is controlled by the Government’s monetary policy, which aims to promote full employment and ensure stable prices.  One would find that when the economy is experiencing low levels of growth the Government uses its monetary policy, say for instance, through the reduction of interest rates, to stimulate growth. Low interest rates encourage consumers to increase their consumption levels (and thus demand) and businesses to increase their level of capital spending to meet such demand. As a result, output and employment increase and so does real GDP (Gross Domestic Product) growth. If low interest rates persist, however, the build up in demand results in a situation of “too much money chasing too few goods,” i.e. inflation.

Low interest rates discourage savings and when coupled with high inflation rates, deteriorate the purchasing power of money. Individuals would prefer to consume today, rather than save for the future. The low levels of savings would impinge on future growth, since there will be less money available to fund business expansion. All of this results in low real economic growth. In short, there must be a balance between prices, inflation and interest rates. One way of striking this balance is through effective monetary policy, which manages the liquidity in the economy.  Of course, the situation is reversed given low levels of liquidity, which also impinges on growth since it results in higher interest rates and discourages consumption and investment.  As a consumer, it is good to take advantage of low interest rates. If you need to take a mortgage or buy a car or furniture, now might be the right time, since it is cheap to borrow. However, once inflation starts to be a concern, you will see some upward movement in interest rates.

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“All information contained in this article has been obtained from sources that CMMB believes to be accurate and reliable. All opinions and estimates constitute the author’s judgement as of the date of the article; however neither its accuracy and completeness nor the opinions based thereon are guaranteed. As such, no warranty, express or implied, as to the accuracy, timeliness or completeness of this article is given or made by CMMB in any form whatsoever. CMMB and/or its employees or directors may, where applicable, make markets and effect transactions, or have positions in securities or companies mentioned herein. Neither the information nor any opinion expressed, shall be construed to be, or constitute an offer or a solicitation to buy or sell.”