Stock Split
Company stock split is when they decrease the price of the share by splitting each share into two or more shares.
When a company wants to increase the liquidity of its shares, they divide the existing shares into multiple new shares. In other words, a company stock split is when they decrease the price of the share by splitting each share into two or more shares. The shareholder’s overall stock value will not change and nor will the market capitalization of the company.
A stock split will lower the individual share price. Small investors who could not buy the share at a high price, say $900, will now be attracted to the lower stock price after the split. A business can take one share and split it into two or three shares. If they split it into two, both shares’ total value will be equal to the price of the old individual share.
What is Stock Split?
A corporate action where a company increases its shares by issuing more shares to existing shareholders is called a Stock split. This process does not alter the company’s overall market capitalization or the value of each shareholder’s stake; it simply divides the existing shares into multiple new shares, thereby reducing the price per share proportionally.
How Stock Splits Work?
When a stock undergoes a split, shareholders receive additional shares based on the split ratio determined by the company’s board of directors.
Let’s say a company XYZ has completed the stock split of 2-for 1. Before the stock split, the original share price was $50 per share; this means that the new share price after the split will be $25 per share after the stock split.
For existing shareholders, a stock split does not change the total value of their holdings, just the number of shares and the price per share.
Reasons For Stock Splits
A stock split is a common thing to do in multi-billion dollar public companies. These big companies grow in value due to product launches, share repurchases, and acquisitions. In the future, at a point in time, the quoted market value of the company stock rises to a point where it becomes costly. Regular investors cannot afford these high prices, the number of investors who can afford to buy the shares fall, thus reducing the shares’ market liquidity. So these companies undergo a stock split to attract more investment into the firm.
Companies typically opt for stock splits for several reasons
- Attracting Investors – A lower share price can make a stock more appealing to potential investors who may have been priced out previously. For example, if a company’s stock price reaches $1,000, a split can make it more attractive to new investors by reducing the price to a more manageable level.
- Improving Liquidity – By lowering the price per share, stocks become more accessible to a larger number of investors, which can increase trading volume and liquidity. This is particularly important if the stock price has risen significantly, making it less affordable for smaller investors.
- Psychological Factors – Stock splits can create a perception of growth and stability, signaling to the market that the company is performing well. This lead to increased demand and higher stock prices following the split.
Stock Split Ratios
The most common stock split ratios are given in the table below:
Stock Split Ratios | Definition | Example |
---|---|---|
2-for-1 | Each existing share is split into two shares | If you held 100 shares before the split, you would hold 200 shares afterward, with each share worth half of its pre-split price. |
3-for-1 | Each existing share is split into three shares | If you held 100 shares before the split, you would hold 300 shares afterward, with each share worth one-third of its pre-split price. |
3-for-2 | For every two shares held before the split, shareholders receive three shares. | If you held 100 shares before the split, you would hold 150 shares afterward, with each share worth two-thirds of its pre-split price. |
Other ratios such as 4-for-3, 5-for-2, and 5-for-4 are also utilized, but they are less commonly seen. More recently, companies like Amazon have carried out larger splits, for example, a 20-for-1 split, to make their shares more accessible to a wider range of investors.
What is Reverse Stock Splits?
A reverse stock split consolidates shares to increase the per-share price. This is often done to meet minimum price requirements for stock exchange listings or to improve the company’s image when the stock price has fallen significantly.
For example, in a 1-for-2 reverse stock split, a shareholder with two shares would end up with one share worth twice as much, but the total investment value remains unchanged.
Reverse stock splits can offer several potential benefits to companies despite often being viewed negatively by investors, even though Investors should carefully evaluate the company’s underlying financial health and reasons for the reverse split before making investment decisions.
Create a Positive Shift in Investor Sentiment!
Overall, stock splits do not affect the fundamental value of a company but can enhance liquidity and make shares more attractive to investors. While they can lead to short-term price increases due to heightened demand, the long-term impact on stock performance varies and depends on the company’s overall health and market conditions.
Eqvista offers complete tools and guidance for managing stock splits and distributing equity among founders, investors, and employees. Contact us to learn more.
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