Stock splits are corporate actions where companies divide their existing shares into multiple shares. This action increases the number of outstanding shares of the company, boosting liquidity. Although stock splits increase the number of shares, they don’t impact the market capitalisation of the company in any way.
The primary objective of stock splits is to bring the value of the stock down to a more accessible level to make it more attractive to a wider investor base. Usually, stock splits are declared in a particular ratio such as 2:1 or 2-for-1, meaning that each share will be divided into two. The face value and the market value of the shares will be divided by 2 to compensate for the split.
Stock splits can be beneficial to companies and shareholders in different ways. Check out the advantages of stock splits here.
Improved Affordability
When stock splits happen, the price per share reduces. This makes the shares of the company more affordable to smaller retail investors with less capital at their disposal.
Increased Liquidity
The newfound affordability after a stock split may encourage more investors to buy or sell the shares of a company. This higher trading activity leads to increased liquidity.
Positive Investor Sentiment
Investors may view stock splits as positive signals. It may lead to more confidence in the company’s management and lead to a bullish sentiment about the company.
Higher Demand
The bullish sentiment can, in turn, lead to higher demand for the company’s shares after they have been split. This, in turn, could drive the share prices up.
A reverse stock split is the opposite of a stock split. Here, a company combines its outstanding shares by combining them. This reduces the number of equity shares overall and increases the share price. So, investors will have fewer shares overall, but the total value of investments will remain unaffected even if there is a reverse split.
For example, say a company announces a 1-for-10 reverse share split. And assume you own 100 shares in the company priced at Rs. 100 each (total investment value of Rs. 10,000). This means that after the reverse split, you will hold 10 shares priced at Rs. 1,000 each. So, the total investment value remains unchanged, at Rs. 10,000.
Companies generally announce reverse stock splits to boost their share prices or to improve how investors perceive them in the market. A higher stock price may make the company appear more stable and attract institutional investors who avoid low-priced stocks.
Reverse stock splits can also be beneficial to investors and companies in some ways. The key benefits of reverse splits include the following:
Reduced Volatility
Stocks that are priced on the lower end of the scale may be susceptible to higher volatility. By executing a reverse stock split, a company can reduce the volatility of its stocks in the market.
Improved Perception
A reverse share split can also potentially improve how a company is perceived in the market. This is because the share price increases after a reverse split. This could increase the perceived value of shares.
Better Liquidity
When a reverse split occurs, the number of outstanding stocks in a company reduces. This, in turn, reduces the supply of stocks. As a result, institutional investors may find these stocks more attractive, leading to an increase in trading volume.
A reverse stock split can also be potentially disadvantageous because of the following limitations:
Affordability Issues
After a reverse stock split, the higher stock price may make it less affordable for small investors. Previously, these investors may have been able to buy multiple shares at lower prices, but the increased per-share cost could limit their ability to invest or reinvest.
Potential Bearish Movement
Although the stock price may rise after a reverse split, the increase could be temporary. Investors may sell off shares because of the negative perceptions. This, in turn, could lead to a further decline in price.
No Change in the Company Value
A reverse stock split doesn’t improve the company's financial performance or underlying fundamentals. It only changes the stock’s appearance by adjusting its price. This can mislead some investors into thinking the company has made meaningful improvements.
The stock prices actually fall after a split since the primary objective of the corporate action is to reduce the market value of the shares to bring it down to a more accessible level for retail investors.
The decision to buy a stock before or after the split depends on factors like your goals, investment horizon, risk profile and strategy. Some investors prefer to purchase the stock before a split anticipating a potential increase in the share price due to increased demand, whereas others may prefer to purchase the stock after the split due to the lower entry price.
Stock splits don’t affect the profits of the company in any way. However, they reduce the Earnings Per Share (EPS) of the company in the same ratio as the stock split. For instance, in the case of a 2-for-1 stock split, the EPS will be reduced by half after the split.
Yes. Companies have the freedom to choose the ratio of the stock split as they wish. Although the most common ratio is 2-for-1, there have been instances where companies have split their shares in 3-for-1 and 5-for-1 ratios.
A stock split doesn’t make a company more valuable or less valuable. In fact, it doesn’t affect a company’s valuation at all. It only increases the number of outstanding shares and reduces the share price to make the stock more attractive to a wider range of investors.
No. The market value and capitalisation of the company remain the same after a stock split. Since the increase in the number of shares is matched by the reduction in the value of the shares, there won’t be any change in the market value.
A stock split is largely considered to be a good move for both the company and investors. Since a split increases the total number of outstanding shares, the liquidity in the counter increases, benefiting both the company and investors. The subsequent reduction in the value of the shares benefits investors since it makes the shares more accessible and attractive to a broader investor base.
A stock split has a major impact on the share price, total number of outstanding shares, liquidity, dividend distribution and stock perception. It increases the number of shares and liquidity while simultaneously decreasing the share price and dividend per share.
The primary disadvantage of a stock split is the potential spike in volatility, leading to temporary price distortions. It also leads to a reduction in the Earnings Per Share (EPS) and Dividend Per Share (DPS), which can negatively impact the way investors perceive the company’s shares.
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