- There are a large number of stocks from different companies that are traded in the stock market.
- Some stocks are traded at lower rates; some are highly valued; whereas some stocks come with a higher price per share.
What is a stock split?
- Stock split is nothing but a strategy that is employed by the companies.
- It is done by increasing the number of outstanding shares issued by them by splitting the existing shares into shares of smaller denominations.
- The number of shares in the hands of the existing shareholder will increase, whereas the total value of the shares they hold will remain the same.
- A stock split will not lead to any change in the market capitalization of the company.
The best example to understand a stock split is as follows:
- A has 10 shares of X Ltd., where each share is worth Rs. 100.
- Thus, A holds shares with a total value of Rs. 1000.
- Now, X Ltd. decides to split its shares by employing a 2:1 stock split strategy.
- So, each share you hold will be divided into two, and the share price will also be split in half.
- Thus, A will have 20 shares, each valued at Rs. 50, of X Ltd.
- The total value of the shares A will hold will remain the same at Rs. 1000.
Why do companies split their stock?
There are many reasons for the stock split done by the company.
A few of them are as follows:
To make shares more affordable to investors:
- When there is a split in stocks, the price of each individual stock will come down.
- This will make the stock more attractive for investors as it will become more affordable.
- For instance, a high-performing stock of a reputed company can be beyond the range of an investor.
- But when the price is slashed with a stock split, it will allow the investors to obtain them.
- This will effectively increase the demand for the stock in the market, which will also reflect well on the share price.
To improve liquidity
- Shares with a high price are not that easy to trade as they will require a large sum of money for investment.
- This will also reduce the overall trading volume of such shares.
- On the contrary, shares with a lower price are easy to buy and sell.
- This ability to frequently and easily exchange such shares in the market will improve their liquidity.
- Due to this, the spread, i.e., the difference between the bid and ask price, will also tend to reduce.
- A lower spread is always a better price for investors.
To attempt to increase the share price:
- Not every stock split will result in an increase in the share price, but a higher share price can be the final outcome after such a strategy is implemented.
- When the share price becomes lower, the demand for the share will shoot up, and eventually its trading volume will also increase.
- The shares will then become more affordable and lucrative by attracting many investors to invest in them.
To make it easier to rebalance the portfolio:
- It is a very crucial task to update and rebalance your portfolio.
- This is possible with the help of professional portfolio managers who keep tabs on everyday fluctuations in the stock market.
- It is very easy to rebalance the portfolio when the stocks are of lower denominations because it will become easier for you or your manager to sell the shares.
- Also, each trade accounts for a smaller percentage of your total portfolio, which will make it easier to manage and rebalance it.
How does a stock split impact your portfolio?
- A stock split will not suddenly impact the value of the shares that you hold.
- When the number of shares you hold increases, the price per share will be reduced.
- However, if the shares become more attractive, chances are that the share price will soar in the near future.
- So, you can benefit from the overall increase in prices, as the value of your holdings will also appreciate over time.
- Over and above this, a stock split announcement can be an excellent opportunity for you to invest in the shares that were earlier out of your investment budget.
- This will allow you to further diversify your portfolio as well as venture into new sectors in the stock market
How are dividends affected by the stock split?
- In most cases, the dividends that are declared after the stock split can be adjusted in such a way that the total amount of the dividend announced will remain the same.
- This is possible when the dividend per share is reduced as the number of shares outstanding increases.
Let us understand this with the help of an example:
- A Ltd. declares a total dividend of Rs. 20 lakh for its shareholders.
- Prior to the stock split, the number of shares outstanding was 10 lakh, and thus a dividend of Rs. 2 per share was paid out.
- After a 2:1 split, the outstanding shares have increased to 20 lakh, and thus the dividend becomes Rs. 1 per share.
- So, here the dividend amount per share falls, but the total dividend payout will remain unchanged.
- Most of the companies have decided not to split the shares close to the dividend date.
Conclusion
Stock split is a very valuable as well as common strategy that is employed by companies, where they split their existing shares by reducing the price per share and also increasing the number of outstanding shares.
Frequently Asked Questions (FAQs)
Q1) Who benefits from a stock split?
Mutual fund investors are benefiting from the stock split.
Q2) Do stocks fall after a split?
When the company’s stock splits, there is no real alteration in the value of the company.
Q3) Do more people buy after a stock split?
A stock split will not make your investment more valuable in and of itself.
Q4) What is a reverse split of shares?
When a company completes a reverse stock split, each outstanding share of the company will be converted into a fraction of a share.
Q5) Do stock prices increase after a stock split?
A stock split can result in a share price increase, even though there are chances that it may decrease immediately after the split.
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