MintGenie Explains: What are fractional shares?

Drawing upon experience in the US, the Indian government is working on putting in place a framework for fractional shares, TOI reported. The plan is to democratise the purchase of stocks in the country. Against the current regime where an investor has to buy at least one share of a company at a trading price, fractional shares allow an Individual to put in a fixed sum of money to buy a particular stock.

When you think of a share, such as one stock of MRF, you probably think of a whole share. Each complete share, in turn, can be regarded as a piece of the company and its equity. Sometimes even one share is simply too much for an investor. But with the help of fractional shares investors can invest in these shares with less amount. 

What are fractional shares?

A fractional share gives an investor the opportunity to own a small portion, or fraction, of one whole share of stock. Imagine when a company issues shares via Initial public offering, an investor who buys it will own a fraction of the total shares outstanding.

Assume if a company issues 1000 shares, and you bought one share, which means you own 1/1000 of all outstanding shares. But with fractional shares, you don’t have to buy a full share. You could purchase half or a fifth of shares, and own .5/1000 or .2/1000 of all outstanding shares.

Fractional shares are created in different ways, as mentioned below.

Stock Split: Investors may also end up owning fractional shares as a result of a stock split. If a company does a 3-to-2 split, you'd own three shares for every two shares that you own. In this case, an investor with nine shares would end up having 13.5 shares.

Dividend reinvestment plan: With a DRIP, dividends paid out by a company or funds are automatically used to purchase new shares. When this happens, investors can end up with fractional shares.

Mergers and acquisitions: When companies merge or are acquired, their stock may be exchanged for new shares. They generally use a ratio to combine stocks from different companies, meaning five shares of Company A might become three shares of Company B. This process could result in fractional shares. Let's look at an example.

Suppose you hold 24 shares of Inox, which has merged recently with PVR, and the new company (PVR-IXOX) comes out with an offer to provide the stock of PVR-INOX in a proportion of 3 stocks of PVR for every 10 stocks you held with INOX (3:10).

In this case, you can get only 6 shares of  (3*2 = 6) of the new company PVR-IXOX, while the remaining 4 shares of the old company INOX remains (24-20). In this case, you will be eligible for a fractional share of 0.4 (4 shares / 10 = 0.4) of PVR-INOX.

How do Fractional Shares work?

Usually, when an investor bought shares in a company, he will become the registered owner of those shares. But with fractional shares that is different, When the Investor Initiates a trade for a fraction of a share, the broker buys the whole share and makes an entry in the Demat account reflecting the value of ownership.

For Example, If you invest ₹250 in a company with a current market price of ₹1000, your Demat account will display to you that you own 0.25 share of that company, the remaining 0.75 share will retain by the broker, which he can use to distribute out to other fractional investors.

How did it work in the United States?

Many financial services companies are offering Investment in Fractional Shares in the USA.

In 2017, M1 Finance was one of the first companies to offer fractional shares. SoFi introduced this function in 2019, and Square's CashApp and Robinhood soon followed, - giving the trend enough gas to convince Fidelity to launch in 2020.

According to SoFi, a broker that offers both free trades and fractional shares, says, 40% of all trades are fractional versus whole shares and 52% of customers' first trades are fractional.

M1 Finance CEO Brian Barnes told Yahoo Finance that roughly half of its 200,000 trades per day on its platform come in sizes of less than one share.

Robinhood will allow investors to place real time-fractional share orders in dollar amounts as low as $ 1 or share amounts as low as 0.000001 shares rounded to the penny during market hours. Even if a stock costs a few thousand dollars per share, an investor can own a portion of a share for $1.

Not all investments are eligible for fractional share orders. Stocks worth over $1 per share with a market capitalization above $25 million are eligible, for fractional shares on Robinhood.

Benefits of Fractional Shares

A wider pool of Investments: Investors with limited money were often limited to penny stocks. These equities are usually companies investors never heard of that are high risk and often very poor investments. But with the help of fractional shares, investors now can buy a piece of any publicly traded business, including some of the biggest companies, which trade for thousands of rupees per share.

Diversify your portfolio with less money. One of the basic rules of portfolio construction is diversification. By owning a variety of different stocks you can reduce the likelihood of losing money. Fractional investing lets you buy many shares for ₹50 to ₹500, you may be able to buy broader selections of stocks than you could otherwise.

Better averaging options. With Rupee cost averaging, you invest a set amount of money regularly. Over time, this may let you pay less per share than you would buy all of your shares at once. Because rupee cost averaging is focused on a consistent rupee amount, not a consistent share amount, it works better when you’re able to invest that full amount. Otherwise, some of your money has to sit in a cash account before you have enough to buy a full share.

Does India allow Fractional shares trading?

Currently, the law does not provide for such investments in India and the ministry of corporate affairs is proposing amendments to the Companies Act to provide for fractional shares, TOI reported. “Issues around bonus shares, rights issues that need to be sorted. The benefit that will accrue is not clear at the moment as there are challenges,” said an executive at a stock exchange While the law will provide the framework there are multiple steps that will be required from a regulatory standpoint. 

For instance, market regulator Sebi will allow for such a regime in the first place. Even tax authorities will have to provide for it in their statutes.

Zerodha co-founder and CEO Nithin Kamath said fractional investing has been the biggest reason for stock market participation to go up in the US.

Zerodha, along with a startup, has applied under SEBI regulatory sandbox to launch fractional investing same in India.

"In the US, stocks bought by customers are held in the street name of the broker, unlike in India, where stocks are held in a customer’s beneficiary account with a depository," he said.