What is stock split? And How stock split works?
What is stock split? and how stock split works?
I’m eating a cookie. But just because I’m breaking it into two, doesn’t mean I’m going to share it. Both pieces still belong to me. Both are going to end up in my stomach. Likewise, breaking a cookie into 2 doesn’t make it into 2 cookies or it doesn’t increase the weight or size of cookie.
Let’s use this idea to understand stock splits.
Why stock split happens?
A stock split happens when a company increases the number of its shares to boost the stock’s liquidity. Stock splits are amazing to make stocks more affordable.
How stock split happens?
Stock splits are always done on the basis of face value. For example, if the face value of a stock is Rs. 10, and the company does a 1:1 split, every shareholder receives one extra share for each share that he/she owns, and the face value gets split in half. So, every shareholder with one share now has 2 shares and the face value of each share is now Rs. 5 from the older face value of Rs. 10.
What happens to value of the company during stock split?
Although the number of shares outstanding increases by a specific multiple, the total value of all shares outstanding remains the same, because a split does not fundamentally change the company’s value.
On what ratio stock split happens?
A company’s board of directors can choose to split the stock by any ratio. For example, a stock split may be 2-for-1, 3-for-1, 5-for-1, 10-for-1, 100-for-1, etc. A 3-for-1 stock split means that for every one share held by an investor, there will now be three. In other words, the number of outstanding shares in the market will triple.
What is reverse stock split?
Reverse stock splits are the opposite transaction, in which a company lowers, instead of increasing, the number of shares outstanding, raising the share price accordingly.
So, how does stock split improve the stock price?
Companies often choose to split their stock to lower its trading price to a more comfortable range for most investors, and to increase the liquidity of trading in its shares.
Most retail investors are more comfortable purchasing, say, 10 shares of a 1000 rupee stock as opposed to 1 share of a 10,000 rupee stock. So when the share price has risen substantially, many public companies end up declaring a stock split to reduce it.
Now an expensive stock has become affordable since it’s price has been reduced, so many retail investors end up participating, often causing a small rally. Many times, post split, and sometimes even just after the announcement of the split, the stock ends up rallying a little bit.
Do stock splits change the shareholding pattern of a company?
If I own 1% of a company, will I own any less of it after the split? Definitely not. The split is uniform for all the shares across all the shareholders. Hence, it does not dilute the pattern of shareholding at all.
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