What is Stock Split?

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  • 10 Jul 2023

Stock splits are a common phenomenon in the financial world, often generating interest and curiosity among investors. As the name implies, a stock split refers to the division of a company into multiple new existing shares. While the company's total market value remains the same, the number of outstanding shares increases proportionally. Read on to learn the mechanics of stock splits, the reasons why companies undertake them and examine their impact on investors and the overall market.

When a company decides to execute a stock split, it aims to increase the liquidity and affordability of its shares. Typically, a stock split is denoted by a ratio - 2-for-1, 3-for-1, or 3-for-2 - indicating the number of new shares received for each existing share held. For instance, if a stock split happens in a 2-for-1 stock ratio, every shareholder would receive two shares for every share held before the split.

One of the key effects of a stock split is the adjustment of share prices. Following a stock split, the price per share decreases proportionally to maintain the same overall market capitalization. For instance, if a stock trading at Rs 100 per share undergoes a 2-for-1 split, the new price per share would be Rs 50. While the number of shares doubles, the overall value of the investment remains unchanged.

Enhancing Liquidity and Attracting Investors

Stock splits aim to increase the liquidity of a company's shares. Lower share prices resulting from a split often make the stock more accessible to a broader range of investors. By reducing the barrier to entry, companies aim to attract new investors and potentially broaden their shareholder base. Additionally, higher trading volumes generated by increased liquidity can enhance price discovery and market efficiency.

Psychological Impact and Perception

Stock splits can also have psychological implications for investors. A lower share price resulting from a split may signal that the company is confident about its future prospects. The reduced price might make the stock appear more affordable, encouraging existing shareholders to accumulate more shares. Moreover, a stock split can generate positive media coverage and public attention, further enhancing the company's visibility.

Options for Existing Shareholders

When a stock split occurs, existing shareholders are granted additional shares in proportion to their existing holdings. This means that their ownership percentage remains the same despite the increase in the total number of outstanding shares. The split does not dilute their ownership stake. However, it is worth noting that the value of each individual share decreases, potentially impacting metrics like earnings per share (EPS) and dividends.

Impact on Market Capitalization

While a stock split alters the number of outstanding shares, it does not affect the company's overall market capitalization. The market capitalization is computed by multiplying the share price by the total number of outstanding shares. Although the number of shares increases, the price per share adjusts proportionally, ensuring the market capitalization remains the same before and after the split.

To Sum Up

Stock splits are a mechanism used by companies to increase the accessibility of their shares and enhance liquidity. Through the adjustment of share prices, stock splits aim to make stocks more affordable and attract more investors. While the number of shares held by investors increases, the overall market value remains unchanged. By understanding stock splits, investors can make informed decisions based on their investment goals and risk tolerance.

FAQs

A stock split refers to the division of a company's existing shares into multiple new shares. The company's total market value remains the same, but the number of outstanding shares increases proportionally.

Companies often execute stock splits to increase the liquidity and affordability of their shares. Lowering the share price through a split can make the stock more accessible to a broader range of investors, potentially attracting new shareholders and enhancing trading volumes.

Following a stock split, the price per share decreases proportionally while the total market capitalization remains the same. For example, in a 2-for-1 stock split, the price per share is halved, making it more affordable for investors.

Stock splits are denoted by a ratio, such as 2-for-1, 3-for-1, or 3-for-2. These ratios indicate the number of new shares received for each existing share held.

No, stock splits and reverse stock splits are opposite actions. Stock splits divide shares into multiple new shares, while reverse stock splits consolidate shares by reducing the number of shares outstanding. Companies undertake reverse stock splits to enhance share prices and meet their listing requirements.

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