Learn About Stock Splits in Three Simple Steps

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  • 23 Jan 2023
Learn About Stock Splits in Three Simple Steps

When a company’s share price shoots up, it decides to lower each share’s price by splitting it in a determined ratio to attract new investors. The company issues more shares of a stock without disrupting its current market value. Hence, the number of outstanding shares increases, but the organisation’s overall market capitalisation stays the same, and so does each existing shareholder’s stake value. This practice is known as a stock split. Suppose you bought one share of company X. Now, it decides to go for a 2-for-1 stock split. You will now own two shares of the company instead of one, but each share's value will be half the value of the original single share.

Hence, the overall worth of your shares remains the same as before. A stock split is quite popular among global companies like Tesla, Amazon, GameStop, Alphabet, etc. In fact, Amazon and Alphabet announced 20-for-1 stock splits very recently.

How is it helpful?

Since the value of both the company and your investment remains unchanged, wondering how a stock split could be helpful for both the parties? Here’s how:

  • Makes stocks affordable for investors.
  • Helps expand the company’s stakeholder base by increasing the number of outstanding shares.
  • Aids in creating a positive image of the organisation. Investors are often of the opinion that a company opts for a stock split as part of its growth plans.

Here’s how stock splits work:

  • Multiply your existing number of shares by the number of new shares put out for every existing share. For instance, you own 100 shares of company X. It opts for a 3-for-1 stock split. Hence, you will have 300 (100*3) shares at your disposal post-stock-split.
  • You can calculate the new prices of your shares using the following formula: New share price = Old share price/stock split ratio
  • Following the trial from the previous example, consider the original trading price of the stock was 300. Hence, the new price of the share would be 300 / (3:1) = 100

Bottom Line

People often mix up stock splits with bonus shares. However, the two aren't the same. Stock splits divide the organisation’s outstanding stocks. For the existing investors of the stock, a stock split does not really matter much. For them, the overall value of their stake remains unchanged. Nevertheless, giving out bonus shares impacts only the issued share capitals.

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