Stock Split
A situation where an organization issues extra shares to shareholders, raising the total by a specific ratio based on their previously held shares.
What Is a Stock Split?
A Stock Split occurs when a corporation decides to raise the number of outstanding shares by some certain amount. It is done to increase the liquidity of a particular company’s stock.
A stock split is an organization's action in which they issue extra shares to shareholders, raising the total by a specific ratio based on their previously held shares.
A corporation sets a split ratio when it decides to split the stock. The corporation can choose from a wide range of combination ratios. The most common splits are 2 for 1, 3 for 1, and 3 for 2.
As the split fundamentally does not impact the company’s worth, the total dollar value of all the outstanding shares remains the same, and even the number of shares outstanding grows by a specific number.
When a corporation is concerned about the high price of a stock, it performs a split to lower the price of a share, therefore attracting new investors.
Key Takeaways
- A stock split is a corporate action in which a company increases the number of its outstanding shares by issuing more shares to current shareholders. There isn't any effect on the company's market cap.
- Companies typically perform stock splits to make their shares more affordable and attractive to a broader range of investors. Lower share prices can enhance liquidity and marketability, encouraging trading activity.
- The two main types of stock splits are forward splits and reverse splits. In a forward split, shareholders receive additional shares, decreasing the price per share. In a reverse split, the number of shares decreases, raising the price per share.
- Despite the changes in share price and quantity, a stock split does not affect the intrinsic value of the company. The overall value of a shareholder's investment remains unchanged immediately following the split.
Understanding a Stock split
It increases the total number of outstanding shares by lowering the value of each share individually. While the number of outstanding shares changes, the company’s overall market capitalization and value of each shareholder stake remain constant.
Assume that you own one share of an organization’s stock. If the firm chooses a 2-for-1 split, you will receive one more share, making the total shares you own two, but each share will be worth half as much as the original. Your two shares in total would be of the same value as the one you owned before the split.
Many investors may not be interested in buying one share for $1000. But they will be more comfortable purchasing 100 shares if the same share is given for $10 per share. So when the stock price rises, an organization usually declares a stock split to decrease its per share value keeping the total market capitalization constant.
As this does not affect the fundamental value of your investment, you will not notice any significant changes in the value of your investment account other than the number of shares.
On the other hand, it can motivate individuals who aren’t currently shareholders to invest. For example, if you could not get Apple’s share before the latest stock split due to the high price per share, you might be able to now.
In summary, it has little impact on the company’s current shareholders. The main impact is on potential investors who are watching stock and expecting to buy a share at a full share at a lower price. It can be a potent stimulus for those investors who have been sitting on the sideline.
What are the Reasons for a stock split?
There could be several reasons; some of the major ones could be the following:
- It boosts valuation
- It reduces the cost of capital for the company
- It also helps customers, employees, and staff
The question arises: why would a company go through all the hassle to increase its outstanding shares when it doesn’t even affect its market capitalization?
There are several reasons. The two common reasons are:
First, a company’s stock price is generally high when it decides to split, making a standard lot of 100 shares incredibly expensive for individual investors.
Second, higher outstanding shares can mean more liquidity for the company, making trading easier and narrowing the bid-ask gap. Increasing a stock’s liquidity makes it easier for buyers and sellers to trade it.
Traders and investors can acquire and sell firm shares without significantly impacting the stock price. This can also enable firms to repurchase their shares at a reduced cost, making a big impact on the business.
Theoretically, it should have no effect on the stock’s price, but it frequently results in renewed interest from the investor, which can boost the stock price. For example, splits by blue-chip companies are an optimistic signal for investors.
When a company’s stock price climbs to a point where many investors are priced out or when the price has increased much higher than its competitor’s shares, then this is a smart decision.
Many of the top firm’s stock prices regularly return to the level at which they previously split the shares, resulting in another split.
For instance, Apple’s stock had been split the following times. On August 28, 2020, the shares were divided 4-for-1; on June 9, 2014, it split 7-for-1; and on February 28, 2005, June 21, 2000, and June 16, 1987, it split 2-for-1.
Example
In August 2020, Tesla split its stock with a ratio of 5:1, giving the investors an additional four shares for everyone they already owned.
The share was trading at around $2213 at that time, pre-split adjusted. The split brought the value of a share down to approximately $498. (2213/5)
This split was done one day after they announced the sale of $5 billion worth of shares. Though it didn’t change anything about Tesla’s fundamentals, it boosted its stock price.
What Is a Reverse Stock Split?
Each outstanding share of a corporation is turned into a fraction of a share when a reverse stock split is completed.
If a corporation declares a one-for-ten reverse split, then each of your ten shares will be converted into one single share. If you owned 1000 shares of the corporation before the reverse split, you would now hold 100 shares
Reasons
A firm may declare a reverse split to raise the trading price of its shares.
For example, if it considers the trading price too low to encourage the investors to buy the shares or to restore compliance with an exchange’s minimum bid price criteria.
Sometimes, small owners are “cashed out” in reverse splits, meaning they no longer are owners or shareholders of the company. There are also chances of investors losing their money due to the swings in trading prices after the splits.
Flaws
There are some drawbacks to these splits. Companies attempt to artificially enhance their stock price in this way which comes with a risk of being shunned by the investors in many circumstances.
These might also be viewed negatively. If a company’s stock price has fallen very low and is at risk of being delisted, a reverse split is more likely. As a result, investors may feel that the company is in trouble and dismiss the reverse split as an accounting gimmick.
Example
On January 3, 2011, Motorola performed a reverse split with a 1-for-7 ratio. This was done to increase the market price of its shares and the liquidity and marketability of its stock.
Following the split, stockholders would possess fewer shares of Motorola company because the number of outstanding shares would decrease. The unit price of shares was expected to rise proportionately, maintaining the overall equity value.
For example, Suppose you were holding 1000 shares of Motorola company until the close of business on January 3, 2011. In that case, the on-for-seven ratio will convert them into 142 shares of Motorola Solutions, and you would have received cash for your fractional shares.
Stock Split FAQs
- Splits never affect the fundamentals of your company. As it cannot affect the fundamentals of a company, the value of the company also remains the same.
- It costs money.
- They may attract the wrong investors.
These are generally considered good purchasing indicators, indicating that the company's share price is rising and performing well. While true, a split does not influence the stock's underlying value and provides no practical benefit to investors.
No, a split does not affect the value of your stock or make you lose money; it just changes the number of shares you possess per the ratio of the split.
It is often a sign of a company's success and increasing stock price. While this is a wonderful development, it also means that investors are paying more for the stock.
As a result, companies may elect to split their stock to make it more desirable to individual investors.
If you've been considering investing in a firm, the time after a stock split is a fantastic opportunity. It typically indicates a company's success, implying that it could be a smart investment.
It is a corporate move where a corporation issues extra shares to present shareholders to increase the number of outstanding shares. Stock splits can increase trading liquidity and make a stock appear more reasonable to investors.
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