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RSSThis is the first of what should be a continuous stream of commentary from Moneyoga: a detailed look at an investment hypothesis, how it would have performed historically, and whether we can expect it to generate index-beating returns in the future.
Hypothesis: Buy stocks of companies that have declared a bonus or split.
If you are an investor in the Indian markets, you most likely have come across this hypothesis: Stocks that give a bonus or split tend to go give good returns. This seems to have been internalized by most investors to the point that the financial media makes a big deal out of every such corporate action, and (retail) investors rush to buy these stocks. After all, if a stock is going to split 1:2, you will have twice as many shares - for free!
Of course, there is no free lunch in the world. All that happens in a 1:2 split is the number of shares doubles, while the price per share is halved. The market capitalization doesn’t change, nor do the company’s business prospects, revenues, earnings, growth, management, assets, debt, customers, logo, headquarters, . . . you get the point!
But, that has never stopped bullish arguments in favor of such corporate actions, such as:
- The stock is now ‘cheaper’ - more retail investors can now afford it, so it’ll go up.
- The share price halved from 300 to 150. But it’ll soon be back up to 300. That’s how it always happens.
Such reasons don’t have much logic - but traders do speculate for short-term gains. Also, in some cases there may be real (tax) benefits - check Deepak’s post to understand how: Bonus shares: A tax saving scheme?.
But here at Moneyoga, we are looking at this as a data/system based investment strategy, so we need to look at historical statistics, expected returns and such - instead of a discretionary, case-by-case approach.
Everything that can be tested must be tested.
What we have done therefore is test if this hypothesis is really true - if you invested an equal amount in each stock that declared a bonus or split, would you really have made returns that beat the index?
We ran a series of tests on historical price data for all NSE stocks. Each time a company declared a bonus or a split, we invested a fixed amount. We held it for a certain period, and then computed the percentage return. At the end of the entire test period, we compared the net return for this strategy (and the worst drawdown) with that for the Nifty-50 index.
Of course, we varied a whole bunch of parameters while back-testing this strategy, as follows:
- Time periods: 1990-2007, 1995-2007, 2000-2007, 2000-2003, 2004-2007, etc.
- Entry dates: Buy the bonus/split stock on the Ex-Date, 1 week after the Ex-Date, 2 weeks before the Ex-Date, etc.
- Holding periods: Sell the stock after 1 day, 1 week, 1 month, etc.
- Market capitalization: Buy only large cap stocks, buy only small caps, etc.
- Type of corporate action: Buy only stocks that declare bonus, buy only those declare a split, etc.
The verdict
We obtained several insights into how stocks perform before & after corporate actions such as a bonus or split. Here are the salient ones:
- Bonus stocks
- If you invest an equal amount in every bonus stock on the effective date of the bonus (aka Ex-Date), you would not beat the index (Nifty-50), whether you held it for one day, one week or one year.
- If you invest an equal amount in bonus stocks - but only the large cap ones - you would be better than investing in the small cap ones; yet you would barely match the index returns in the short term; but have to take twice as much risk (drawdown) as the index.
- This is true regardless of the historical time periods tested (bull markets, bear markets, etc.).
- This is true even if you bought the stock as soon as the corporate action was announced - usually 3-4 weeks before the Ex-Date.
- The best scenario is when large-cap stocks are bought as soon as the bonus is announced and are held for 9 months or longer.
- Split stocks
- The same conclusions as for the bonus stocks hold here as well; except that for large cap stocks, the strategy comes close to beating the index in the short term.
The chart above shows the statistics for a strategy that buys both bonus and split stocks, as soon as the corporate action is announced. We filtered out small cap stocks (defined as market capitalization < Rs 5000 crores). The lines show the expected return (aka expectancy) and the worst risk (aka drawdown). The bars show risk & return for the case where we invest the same amount in the Nifty-50 index instead of the bonus/split stock.
The X-Axis shows the number of days for which each bonus/split stock is held. You can see that the strategy gets better & better for longer holding periods. The blue dashed line marks a holding period of 1 year.
Bottom-line
The best strategy (in terms of risk-adjusted returns) is: Buy every large-cap stock (defined as market capitalization > Rs 5000 crores) as soon as the company declares a bonus or a split, and hold it for at-least a year. This also ensures that you benefit from the (zero) long term capital gains tax.
18 responses so far ↓
1 Ajay // Dec 21, 2007 at 4:35 pm
Nice analysis .
Refreshing change than others .
Please also analyse for MFs and post more often .
Thanks .
2 Sivaprakasam // Dec 24, 2007 at 4:09 pm
Thanks. I thought for a longer time before applying for TATA STEEL’s rights issue.
3 deepak // Dec 26, 2007 at 12:25 am
I do not agree with this analysis. u should have studied from the day the company had declared the bonus. for growing companies, the companies stock tends to double if 1:1 bonus is announced. Pls. do & present that analysis.
4 deepakshenoy // Dec 26, 2007 at 1:12 am
deepak: We’ve checked from four weeks earlier too, which is typically when bonus announcements are made (4 weeks before the ex-date that is).
This is the universe of stocks that have declared bonuses/splits and the assumption is that you would invest in every single one. Kaushik has also filtered the list by market cap (i.e. investing only in stocks with market cap > 5000 cr.) and results are shown.
The usual problem is that you hear about stocks that have doubled or done well, but you don’t hear about the losers quite as much. The double theory is just wrong - I know hundreds of stocks that have NOT doubled post their recent bonuses (Praj, Jai corp, TCS and so on)
5 manoj.p.v. // Dec 27, 2007 at 5:46 pm
the assumption that there will be agood appreciation of the particular stock that has announced a bonus/split, is indeed incorrect as the fundementals remain intact,we people behave the same,like we usually tend to go to go to a shop who has displayed an” OFF SALE”more often, than to a shop where there’s
6 destiny // Jan 3, 2008 at 12:58 am
True I agree with manoj p . v. few of them has realy given good returns, i ve lostmoney in vishal exports , TCS
7 Raj // Jan 5, 2008 at 8:57 am
Great analysis. Keep going
8 Nilesh Agrawal // Feb 17, 2008 at 12:33 pm
Good comprehensive analysis; something which I always had lurking behind in my mind.
I would like to add one more variable here… Management Quality…does this return significantly vary with companies managed well. Say a Seimens, TCS, Tata Steel and the likes. M-cap is a good surrogate, but would have liked to see there is a differential.
9 kaushikgala // Feb 17, 2008 at 7:12 pm
Nilesh: Management quality is certainly an important factor. The issue here is that we can’t really quantify it, and hence “screen” for it. Of course, you can always take our Bonus/Split candidates as a starting point, and further refine those picks using MQ, etc.
10 New Features: Sectors, Watch List, Bonus & Split Candidates // Feb 22, 2008 at 11:21 am
[…] investment strategy that we investigated using historical data, discussed in an earlier blog post: “Buying Bonus & Split Candidates: A Profitable Investment Strategy?”. We showed that buying large-cap stocks as soon as a bonus or split is announced has historically […]
11 John // Mar 12, 2008 at 7:30 pm
Good analysis. Will take a closer look at this in the future. Thanks for pointing to it.
12 Raghuram // Apr 16, 2008 at 12:32 pm
I wonder whether based on a Total Shareholder return basis after including uninvested dividends at risk-free rate whether the returns would beat the index.
Any views
13 seo // May 9, 2008 at 3:27 pm
Nice site and also this article……
14 Saurabh Mangal // May 30, 2008 at 2:28 am
Hey Guys,
Good job done here. This is what I had planned to take up as one of my summer projects in my MBA days but lost the momentum and left it in midway. I know how much effort it requires. I really appreciate your effort.
Regards,
Saurabh
15 Vinay // Jul 30, 2008 at 9:54 pm
Hi Deepak,
Can you pls provide the bonus issues this year whose record date has not yet happened.
Thanks and Regards,
Vinay
16 Nishant // Oct 5, 2008 at 12:26 am
Hi
Did you also look at the loss/gain in terms of dividend income when bonus is announced? Do companies cut down dividend?
specifically, if we look st recently announced Bonus issue for SCI (1:2), with a high dividend, do you think SCI would continue the kind of dividend it gives investors??
17 ravi // Oct 18, 2008 at 9:57 pm
hi deepak
you have just looked at the bright side
but the realty is some how different,
as the case with R-power,
tata steel rights issue , l&t bonus etc
your strategy only makes sense in the bull market with good investor’s sentiments
it dosen’t hold good for present situation
18 TIP Guy // Apr 12, 2009 at 10:07 pm
Kaushik,
I may be biased because of my preference for company fundamentals. My viewpoint is bonus/split as a standalone should not have any benefit. What it is does is increases liquidity, dilutes the shareholding, and physiological aspect that it is cheap. From business standpoint, I do not think it should affect companies performance matrices. Contrarily, the increase in share price is purely speculative which one cannot ignore. The best example is Visa vs. Mastercard. You looked at referencing with the index. Any thoughts on how does this look w.r.t. companies own performance matrices? i.e. does it really help individual companies.
This was a good read !
TIP Guy
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