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Highlights
- Companies carry out stock splits with an aim of increasing the trading potential of its stocks.
- Stock splits keep the market capitalization unaffected while increasing the total number of shares.
- A stock split helps investors purchase a higher number of shares at a lower investment.
A stock split is a process where a company increases the number of its shares but also lowers the price. In this, the number of shares is inversely proportional to the price of the stocks. Despite the number of shares increasing at a substantial level, the total value of all the shares remains the same.
There are certain stock split ratios that are commonly carried out by companies. They are 2-for-1 or 3-for-1 and often denoted as 2:1 or 3:1.
This implies that if a stockholder has 1 share of worth US$ 50, and if the company goes for a 2-for-1 stock split, the value remains the same but now there are 2 shares worth US$ 25 each post-split. This keeps the total amount unchanged but increases the number of shares. Therefore, the value per stock changes but the shareholder’s stake remains the same in the company.
Why do companies go for stock splits?
Companies carry out stock split with an aim of increasing the trading potential of the stocks. Investors who are in the market with comparatively smaller budgets prefer to buy shares at a lower price. In this way, the shares’ marketability leads to a direct influence on the price. So, when more people go for a company’s shares, the prices tend to rise.
By going for a stock split, the company aims to attract a greater audience and investors. A company usually draws a higher number of investors after a stock split. As mentioned in the above example, after a stock split, you can attract an investor with a budget of US$ 25 per stock. This implies that the marketability of the share has increased. Normally, due to this, it becomes easy to buy and sell shares.
Advantages of Stocks Splits
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Increases Liquidity
Stock splits keep the market capitalization unaffected while they increase the total number of shares substantially. When a company with 30 million shares is split up into 90 million shares, the current rate of share inevitably decreases to a more economical level. This may attract and encourage small-sized financiers.
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More number of shares to existing stockholders
The existing stockholders can own a greater number of stocks without investing any extra money.
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No Excess Tax Liability
There is no need for the company to pay additional taxes on the increased number of shares as the marketplace capitalization remains unaffected and unchanged.
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Easier Diversification
Since the number of shares has increased and now are at lower prices, it becomes easier for people to diversify and rebalance their portfolios.
Bottom Line
A stock split significantly impacts new investors helping them in purchasing a higher number of shares at a lower investment. Thus, it can be a powerful motivator to lure investors into the company.
Stock splits attract small-sized investors and supply greater liquidity in the market. There are several arguments for stock splits as a tactical long-term choice for companies as to how they wish to be perceived by the investors.
While a split does not impact the actual worth of the business, it has a notable impact on the perception of the investors for a given stock’s price.
Please note, the above content constitutes a very preliminary observation based on the industry and is of limited scope without any in-depth fundamental valuation or technical analysis. Any interest in stocks or sectors should be thoroughly evaluated taking into consideration the associated risks.
