When you buy a smartphone at a 50% discount, you still get a whole smartphone. However, if you buy half a chicken Biryani, you will actually receive half of the quantity that you would receive in a full chicken Biryani.
Half stock works somewhat like the chicken biryani example.
What is half stock
Just like half a chicken Biryani gets you half of the full plate, when you buy half stock (which is a generic term for a bond or a stock trading at half of its par value/ face value) you get half of the dividends or half the interest.
Half stocks do not refer to a security selling at a discount, but rather to half of a security, and fixed returns will be proportionately halved.
In the case of stocks, although the concept of half stock is agreeable with both regular shares and preferred shares, half stocks most commonly refer to preferred shares. That’s why you’ll often hear half stock and preferred shares in the same sentence.
Fundamentals of half stock: what investors need to know
Let’s get a little background and observe relevant examples to understand how this works.
Stocks can trade at values that are higher than or lower than their face value, depending on demand and supply and other dynamic factors that affect stock prices.
The face value might not mean much when you’re simply trading shares, but when it comes to earning dividends, it takes on significance, because dividends will usually be a percentage of the stock’s par value.
Let’s say a dividend stock of Company A has a par value of Rs 2500 but company A decides to issue half stock. Investors can now obtain shares much more affordably – at Rs 1250 – and will correspondingly earn Rs 125 instead of Rs 250 when the company declares a 10% dividend.
Bonds can similarly trade at values that are higher or lower than their face value depending on how their interest rates compare with market interest rates and other similar factors.
The face value or par value of a bond is significant to investors who look at the bond (or more specifically, it’s interest payouts) as a source of regular income, because interest is typically a percentage of the bond’s face value.
Company B issues bonds for Rs 5000 at 5% interest but decides that it now wants to issue half stock for Rs 2,500. The bond issuers purchasing the half stock securities will get 5% of 2,500 because the par value of their bonds is Rs 2,500.
How traders may use/trade half stock:
Investors may use any number of strategies to trade half stocks; here are a handful of possibilities to give you an idea
- A long-term may purchase half stock to gain exposure to a company or sector that he would otherwise not be able to afford.
- Traders may also go the half stock way in a bid to diversify their portfolios despite having a smaller amount of capital.
- Receiving half the dividend or interest on shares or bonds respectively might not matter to a day trader or investor who is looking to conduct many trades and earn from small price differences in the entry and exit price.
- An investor might opt for half stock in a bid to be able to afford preferred shares. Preferred shares give the shareholder priority in receiving a share of the company’s assets, in case the company goes belly up. Regular shareholders are way lower down the list when it comes to gaining a piece of the spoils.
- Some investors might consider half stock as a low risk means to gain exposure to a high-risk company when the half stock is for preferred shares. This is because they stand to get back their capital even if the company becomes bankrupt – even if they have not managed to exit potentially profitably before any news of bankruptcy gets out.
Should you invest in half stock?
Investors should consider the reasons why the company has decided to issue half stock, whether this refers to bonds or shares.
Is the company in dire need for capital because they are facing a financial crunch of some sort? It might not bode well for investors if the company is seeking additional capital through desperate measures, so as to settle crushing liabilities.
However, the stock issuing company or the bond issuer could also be in dire need of capital for expansion, or to fund an acquisition, or for a growth-oriented project that could potentially deliver good ROI to investors. That could instead bode well for investors.
The company might also be issuing half stock to make their shares or bonds more affordable in response to some competition, or a changed market scenario. This could go any way, depending on how things play out for the stock issuing or bond issuing entity.
Preferred stock or not, affordable bond that you would not otherwise be able to buy or not, all stock market securities come with attached risk. Indeed, you might be halving your risk by investing in half stock shares or bonds, but that does not negate the need to evaluate the risk profile of the stock issuing or bond issuing company.
For any stock market investments – including half stock- investors should conduct due research and see to it that they have a regular income and sufficient capital in place to carry on their present lifestyle before they carve out capital for investment.