The Hindu Business Line : The other side of ‘face’

The move by SEBI (Securities and Exchange Board of India) to usher in a regime of uniform face value for listed shares is welcome, though there can always be difference of opinion as to what exactly it should be.

SEBI has mooted Re 1 as the norm; it could arguably have been Rs 10, the prevailing face value for majority of the listed shares. The reason why SEBI has zeroed in on Re 1 could perhaps be to accommodate the concerns of both companies and invest ors. Many companies have gone for stock-splits in the past so as to have a face value of Re 1 per share. This does lull an investor into some sort of complacency — that the share has become affordable.

To wit, if a Rs 10 share was quoting at Rs 1,000 but quotes at Rs 110 after the reduction of face value to Re 1, it gives an illusory feeling that the share has become cheaper, though on a deeper reflection it would be obvious that it has become 10 per cent costlier instead. Be that as it may.

The fact is multiplicity of face values did confuse investors and defied inter-company comparisons. Within the IT sector, for example, you have an array of face values which frustrate inter-company comparisons unless you have the patience and time to equate the figures through a uniform multiplier. The SEBI move, in the event, is eminently in investors’ interest. It is as much welcome as the Finance Minister’s initiative in ushering in a uniform ‘previous year’ .

A misconception

There is a view that a Re 1 face value ipso facto amounts to abolition of the concept of face value. This is wrong. While it is true that with Re 1 as the face value, there would be parity between the number of shares subscribed and the share capital, assuming there are no arrears or uncalled capital, it does not mean that the face value would disappear or lose relevance.

In India, dividends have traditionally been expressed as a percentage of the face value, admittedly fostering a wrong impression in lay investors’ minds. A company that issues its Rs 2 share for Rs 525 may announce dividend of 100 per cent, winning plaudits from experts and lay investors alike.But a moment’s reflection would show that this translates into an ROI (return on investment) of just 0.38 per cent for the original subscribers.

The fault does not lie with the concept of face value. Instead, it lies with the dispensation that allows corporates to get away without having to pay for the funds mobilised in the primary market.

The concept of uniform face value of course does not address this problem, but then that is not the objective of the SEBI move. Its objective apparently is to protect investors from the maze of face values.

Effect on EPS

There is also a view that a Re 1 face value could artificially pull down the EPS (earnings per share). For example, if a company was having an EPS of Rs 25 on shares of Rs 10 face value, it would have an EPS of Rs 2.50, others things being equal, when the face value is brought down to Re 1.

This happens because of the fact that the number of shares has increased ten times bringing down correspondingly the EPS ten times.

Things on the P/E (price-earnings) front however would not be materially different consequent upon such stock split. Continuing with the example taken earlier, if the market price of Rs 1,000 for a Rs 10 share gave a P/E of 40 times with EPS being Rs 25, the market price of Rs 110 on a truncated EPS of Rs 2.50 gives an EPS of 44 times after the stock split. The seeming distortion in the EPS gets straightened if one cares to find out the P/E multiple. In fact, the P/E multiple would have stayed put at 40 times had the market brought down the price pro rata — from Rs 1,000 to Rs 100 — on stock-split.

Stock-split vs bonus issue

Investors should not get the impression that stock split tantamounts to bonus issue. In a bonus issue the share capital gets augmented. In stock-split, it does not. The Americans look down upon bonus issues as a virtual stock split because of the dilution in the net worth. But the truth is bonus issue is born of management’s confidence in being able to plough back the reserves into business profitably, whereas stock split only gives illusory benefits to the shareholders. SEBI, however, should not be blamed for encouraging stock splits because it is going to be a one-off affair after all.

(The author is a Delhi-based chartered accountant.)

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