Personal Finance: Doubling the shares doesn't double the money

Understanding the stock market

Once upon a time, you owned 500 shares in a company. Suddenly, without quite knowing how, you now own twice as many shares in the same firm. Yet their value is half what it was. Confused? John Andrew explains.

It was a terrible start to the weekend. James had not checked the price of his shares for a week or so. All was well since he last looked. There were a few modest gains, a couple had barely moved, while there were a few small losses. The last share price he looked at nearly caused him to choke on his croissant. Two weeks ago it was trading at 300p - now, it was 151p.

He had 1,000 shares in Widgets plc - he could not believe the dramatic fall. Although he had only scanned the financial pages in the last fortnight, he had seen no detrimental news about the company. Then the post arrived. One envelope contained a share certificate for another 1,000 shares in Widgets.

The company had undertaken what in City parlance is called a scrip issue. Technically, this is a capitalisation of reserves. This sounds complicated but it is very straightforward.

Suppose a company begins life with the issue of 1 million shares at pounds l each. The proceeds will raise pounds 1m, which we will assume is used to buy assets for the business. Let us now put the clock forward a few years.

Assume that over that period the company has done well and while the shareholders received dividends, the company also ploughed back pounds 9m of profits into the business. The accounts still show share capital of pounds 1m and reserves of pounds 9m. This is a simplification, but, suppose the company's shares are now priced pounds l0 (the shareholders' funds are pounds 1m + pounds 9m = pounds l0m; pounds l0m divided by 1 million = pounds 10 per share.)

Let us suppose the company's directors announce a "scrip issue" and every shareholder will receive one extra share for every one they own. In City parlance this is called a "one-for-one scrip issue". Each shareholder's holding in the company will double. The company is still worth pounds l0m, but, the number of shares has increased from 1 million to 2 million. Each share is now worth pounds 5 (pounds l0m divided by 2 million shares). In other words, shareholders are no better off as their holding may have doubled, but the share price has halved.

So why does a company have a scrip issue? The popular explanation is that the shares are considered "expensive". In other words, pounds l0 a share may be a barrier for new investors, whereas they will buy at pounds 5. This defies logic, but if you look at the price of shares quoted on the London Stock Exchange, you will notice that prices are generally under 1,000p.

Nevertheless, a scrip issue can have a psychological spin-off which benefits shareholders. Suppose that our imaginary company before the scrip issue had a dividend of 43p per share. After the issue, if things remained unaltered, the dividend would half to 21.5p. The market could take this as a sign that dividends will increase the next year to 22p per share so as to avoid a fractional dividend. To reflect the increase in the dividend payable, the share price could rise slightly.

So what does an investor have to do when a company announces a scrip issue? The answer is usually "nothing". Shareholders will receive notification of the scrip issue from the company. This includes a timetable for the procedure. One of the pertinent pieces of information will be the "records date". James ignored his notification.

All those on the shareholder's register at that time will be entitled to the scrip issue. Five to 10 days afterwards the shares will be quoted "ex scrip" on the market. This means that the price of the shares has been adjusted for the issue. The letters "xc", where "c" stands for "capitalisation", will appear after the price of the shares quoted in the press.

As soon as the new certificates are ready, they will be mailed to shareholders. Those wishing to sell their entire holding before their new certificate arrives can do so, for stockbrokers will be aware of the situation. However, it must be made clear when the sale instructions are given that you wish to sell "old" shares, which are equivalent to a certain number of "new" shares. When the new certificate arrives, it must be forwarded to the broker who dealt with the sale.

Investors who sell shares before the "records date" are not entitled to the scrip issue. Should the company's share register not have been updated in time and consequently a share certificate for the "new" shares is received, this must be forwarded to the broker who handled the sale.

It is only when shares in a company are bought or sold during the period of the a scrip issue that matters become complicated. Your broker will always be pleased to answer any questions that you have and to give guidance.