Understanding the What and Why of Stock Splits

Every investor keeps one eye on the stock market in search of shares that would yield high profits. However, there are situations when investors may not have been able to purchase shares of a highly desired company. The high share price is the cause. These are the moments when businesses choose to split their share. As the name implies, a split stock entails a company’s face value decreasing and a commensurate rise in share capital. The main goal of a split stock is to increase the stock’s liquidity and, as a result, lower the price for investors.

What is a Stock Split Meaning?

A split stock increases the number of shares and decreases each share’s face value, making it simpler for new investors to express interest and invest in the company’s stock. In other words, if more investors buy at lower prices, the number of shareholders may increase. Investors who purchased the split shares at a cheaper price may not gain from a stock split. Even so, split stock signals to an industry that the company’s share price has just been moving north even before the split, and investors believe that the growth will continue. This could be one of the reasons why the share price goes up, if it does.

What is a Forward Stock Split?

In a forward split, the most common type of split stock, a company increases its shares by giving new shares to investors who already own shares. For example, a 3-for-1 forward split means that if you had 10 shares of company XYZ before the split, you would now have 30 shares. The value of your investment as a whole wouldn’t change, though. So, a forward split makes the number of outstanding shares go up, but the price per share goes down. This doesn’t change the market value of the company as a whole.

What is a Reverse Stock Split?

A reverse split stock reduces the number of shares that a company has. For example, if a company’s board of directors announced a 2-for-1 reverse stock split and you already owned 10 shares, you would now only own 5. The value of all of your shares would stay the same. Before the reverse split, ten shares were worth INR 306 per share, while five were worth INR 613 per share. In both cases, the total amount you spend is INR 3065.

Stock Split Ratios

A stock split ratio shows the number of extra shares it will give out after a forward stock split and the amount by which the number of shares will be split after a reverse stock split. For example, a 3-for-1 stock split means that there will be three shares after the split, with two new shares created for each existing share.

Also, it’s important to remember that the stock split ratio can show whether a split is forward or backward. When the first number is larger, this is called a forward split (as in “3-for-1”). It’s a reverse split if the smaller number starts.

What Can You Anticipate From a Split Stock?

Whenever it comes to split stock, there are three important dates that investors should be aware of.

Date of announcement

The company would publicly declare the split’s plans and any important information investors should know. Most of the time, this data includes the ratio of the split and the dates when it will happen.

The date on the file

Although this is a significant day for accounting purposes, investors don’t need to be aware of it. To be qualified to receive new shares produced by a stock split, current shareholders must possess the stock as of the record date. The claim to the new shares does transfer, though, if you purchase or sell shares between the record date and the effective date.

Although it may seem difficult, doing this is fairly easy. The extra shares will show up in your account the morning of a stock split’s effective date, and the share price should be updated correspondingly.

Why Do Businesses Divide Their Stock?

Stock splits are often done when a company’s stock price goes up. Even if a company’s stock price goes up, which is good, some investors think the stock price has gone up. So, companies split their shares to lower the price of their stock and make it more attractive to small investors.

For example, if a share of stock costs 1000, you might not be able to buy it. Now, you would be more interested in investing your 1,000 if you could buy five shares of that stock for 200 each.

Advantages of a Stock Split

Let’s look at how the stock split benefits shareholders now that you know what it means.

It increases the shares’ accessibility.

One of the main reasons firms choose to split shares is high share prices. A huge growth in a company’s share price may reduce investor interest.

The general preference of investors, particularly individual investors, is to purchase 10 shares for Rs. 500 per share as opposed to 5 shares for Rs. 1,000 per share. Through share splits, a company can lower the price of its shares and make them more accessible to investors without changing the value of the company.

It boosts liquidity

The enhanced liquidity of a company’s shares is another one of the key advantages of a stock split. Since shares have become more readily available to individual investors, there will likely be greater demand for them, improving the counter’s liquidity. After a stock split, it’ll be much simpler to buy and sell shares.

Conclusion

In the end, present investors in a company aren’t much impacted by a stock split or even a reverse stock split. Investors who may be keeping an eye on a particular stock and hope to pick up a whole share for a reduced price will be the ones who will be most affected by a stock split. A split stock can be a good reason for such individuals to start trading. If you want more detailed information, then you must visit Piramal Finance, where you’ll get all the necessary information.