Companies, during their journey, take various corporate actions which impact their financial structure and stakeholders. Corporate actions include dividend payout, rights issues, bonus issues, mergers and acquisitions, stock splits, etc. A stock split is one such corporate action that many companies attempt.
In the financial year 2021-22, as many as 169 companies went for a stock split. If you want to understand a stock split, explore this article.
This article highlights what a stock split is, what a reverse stock split is, why a stock split is done, why a reverse stock split is done, its advantages, what happens when a stock splits, stock split companies, and whether a stock split is good or bad.
What Is A Stock Split?
A stock split is a corporate event in which the company splits existing shareholders’ one share into multiple shares, thereby increasing the number of outstanding shares while keeping its market capitalisation the same. In a stock split, the investor’s overall invested amount remains the same, whereas the value of an individual share reduces.
For instance, if a company goes for a 2-for-1 stock split, all its existing investors will get two shares for every one they own.
Assume that you have one share of the company, and the stock is valued at ₹200 per share. After the stock split, you will have two shares of ₹100 each. Thus, the company’s outstanding shares increase while market capitalisation remains unchanged.
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What Is A Reverse Stock Split?
As the name suggests, the reverse stock split is a corporate action in which the company merges existing shareholders’ multiple shares into one share. This way, the company reduces the number of outstanding shares while maintaining its market capitalisation. In a reverse stock split, the investor’s overall invested amount remains the same, whereas the value of an individual share increases.
For instance, if a company goes for a 2:1 reverse stock split, its existing shareholders will get one share for every two shares they own.
Assume that you have two shares of the company, and the stock is valued at ₹100 per share. After the stock split, you will have one share of ₹200. Thus, the company’s outstanding shares decrease while market capitalisation remains unchanged.
Why Do Companies Split Their Stocks?
Companies often perform stock splits when their stock prices have risen. Although an increased stock price is a good sign for a company, the stock becomes less affordable for many investors. Therefore, companies go for a stock split to make their stock affordable and attractive to numerous retail investors.
For instance, you may not afford a stock worth ₹1000 per share. However, that stock may look attractive to you when you can buy five shares worth ₹200 per share and thereby invest ₹1000.
Why Is Reverse Stock Split Done?
- Sometimes companies suffer from pretty low stock prices. In such an instance, the reverse stock split allows companies to improve their stock price.
- It is often done to meet the minimum stock price requirements of the respective stock exchange.
For instance, if the company’s stock is valued at ₹10 per share and goes for a 5:1 reverse stock split, the stock will be worth ₹50 after the reverse stock split.
Types of Stock Split
Stock splits come in many different types, typically defined by the ratio of new shares issued to old ones. The most common types of stock splits are:
2-for-1 Stock Split
In a 2-for-1 stock split, each shareholder receives an additional share for every share they previously held. For example, if you owned 100 shares before the split, you would own 200 shares afterward. A real-world example of a 2-for-1 split is Starbucks, which carried out this type of split on April 9, 2015. Another instance is Monster Beverage Corp., which executed a 2-for-1 split during its fourth-quarter 2022 financial update, and Churchill Downs, which announced its 2-for-1 stock split on April 25, 2023.
3-for-1 Stock Split
In this scenario, shareholders receive two additional shares for every share they owned before the split. This means if you owned 100 shares before the split, you would own 300 shares afterward. Tesla provides a notable example of this, as its shareholders voted in favor of a 3-for-1 stock split at the company’s annual meeting on August 4, 2022.
3-for-2 Stock Split
This split is slightly different in that shareholders receive an additional share for every two shares they previously held. So, if you owned 200 shares before the split, you would own 300 shares afterward. Rollins, Inc., for instance, carried out a 3-for-2 split on October 27, 2020, and PACCAR Inc. announced its 3-for-2 split in December 2022.
While these are the most common types, there have been examples of other ratios, such as 5-for-1 or 7-for-1, and even larger. For instance, in the Indian market, Equitas Small Finance Bank Limited executed a 5-for-1 stock split on May 18, 2023.
Some companies have even carried out 10-for-1 splits, such as Shopify on June 28, 2022, and CESC Limited on April 20, 2023 in the Indian market. And in exceptional cases, even larger splits have been seen, such as Amazon’s 20-for-1 split on May 27, 2022.
These splits can make the stock more affordable and attractive to a broader range of investors, while the total value of the company remains the same, as the increase in the number of shares is counterbalanced by a proportional decrease in the price per share.
Pros and cons of Stock Split:
| Pros | Cons |
| Increases Liquidity – A stock split can make shares more affordable to smaller investors, which can increase liquidity in the stock. | Doesn’t Create Real Value – Stock splits don’t increase the intrinsic value of the company. The total market capitalization remains the same as before the split. |
| Potential Price Increase – With more affordable shares, demand may increase, which can lead to a price increase. | Transaction Costs – If the increased liquidity leads to more trading, transaction costs for the company may increase. |
| Psychological Appeal – Investors may perceive the lower-priced shares as more affordable or as a bargain, which can attract more investors. | Confusion – Stock splits can sometimes confuse investors, especially those who do not understand what a stock split actually is. They might mistake it for a real gain. |
| Broadened Ownership – Lower priced shares might encourage a broader base of ownership, enhancing the company’s corporate governance structure. | Administrative Hassle – Stock splits require administrative work for both the company and brokerage firms. This includes updating shareholder records and costs related to notifying shareholders. |
What Happens When A Stock Splits?
- When a stock splits, the investors’ invested amount remains unchanged while the number of shares in their portfolio increases.
- The ease of pouring in or pulling out the money increases when stock splits.
- Another possible consequence of a stock split is higher price fluctuation in the short term.
Stock Split Companies
Here are some examples of stock split companies.
- ITC (India Tobacco Company Limited) had a stock split in September 2005. After the stock split, its face value changed to ₹1 from ₹10 earlier.
- HDFC had a stock split in September 2019. After the stock split, its face value changed to ₹1 from ₹2 earlier.
- Ultracab had a stock split in March 2022. Its face value changed to ₹2, from ₹10, post the stock split.
[Source: https://www.financialexpress.com/market/stock-market/split-of-face-value/ ]
Is Stock Split Good Or Bad?
There is no accurate answer to whether the stock split is always good or bad. Investors often perceive it as a positive event in the short term; however, in the long run, everything settles down.
Final Thoughts
A stock split is a corporate action in which companies lower the share value by splitting the shares. It often brings an excellent opportunity for investors looking to buy a stock they can’t afford. However, it is not advisable to buy a stock just because it is getting cheaper. Buy the stocks that go in line with your investment goals.
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FAQs
The company and the investors both benefit from a stock split.
– For companies, the advantage of the stock split is that their stocks become more attractive and popular.
– After a stock split, the per-share price comes down, making it easy and affordable for investors to buy.
Neither buying the stock before nor after the stock split offers you assured returns. If you find the stock pricey, you can wait till the stock split as it makes a share less expensive. However, investors usually tend to consider a stock split optimistically. Therefore, investors buying the stock before the event may also see huge returns.
One major disadvantage of the stock split is stock price fluctuations post the stock split. Moreover, the process of stock split incurs hefty legal and administrative requirements costs for companies.
There is no certainty that stocks will go up after a split. However, if the stock performed well before and the investors are bullish about the stock’s future outlook, there are higher chances that the stock will go up after a split.
Stock splits do not necessarily make the investors quickly rich, and it is because the investment amount remains the same even after a stock split, with an increased number of shares.
