Stock Split 101: Understanding the Process and Its Purpose

Stock Split 101: Understanding the Process and Its Purpose

A stock split or reverse stock split allows a company to increase or lower the number of its shares outstanding by dividing them into multiple shares. With this process, the company is able to boost its stock’s liquidity and raise or reduce the price of its shares.

A stock split helps the company push its share price down, which then attracts new investors. Conversely, a reverse stock split pushes its share price up, keeping the company listed on a major stock exchange.

Stock Split Explained

A stock split is a process where the company’s board of directors issues additional shares to existing shareholders without reducing each of their stakes’ value.

With a stock split, the number of shares outstanding grows while the individual value of every share shrinks.

Note that a stock split does not influence the fundamentals. As a result, the company’s overall market capitalization and value of each shareholder’s stake are retained despite the change in the number of shares outstanding.

For example, you own one share, and the company’s board decides to do a 2-for-1 stock split. The company would provide you with more shares. Although each of those shares would be worth half the value of the original. Your two shares would have the same value as the initial share following the split.

Stock splits are generally seen as a positive sign that a company is performing well, suggesting an excellent investment opportunity. Furthermore, since the per-share price is lower, the shares are cheaper, providing you the chance to ramp up your investments.

Reverse Stock Split Explained

As the name suggests, a reverse stock split or reverse split lowers the number of shares outstanding. So let’s say you hold ten shares, and the company opted for a 2-for-1 reverse stock split. That would leave you with five shares after the reverse split while the overall value of your shares remains stable.

2-For-1 Stock Split Explained

A 2-for-1 stock split immediately doubles the number of shares you already own. In this process, you receive two shares for every one share you have. So if you’re holding 100 shares, and the company’s board decided to split the stock, you will have 200 shares once the split is complete.

A 2-for-1 and 3-for-1 stock splits are the most common type of stock splits. On the other hand, Tesla Inc.’s 4-for-1 and Apple Inc.’s 5-for-1 stock split in 2020 are a few examples of stock splits that you don’t regularly see in the market.

The Purpose of Stock Split

Companies often use a stock split to make their stock prices more appealing and available to investors. This thereby increases their liquidity. You may not invest in a stock for $600, but you might consider doing it if the stock is at $120.

Meanwhile, the company’s board usually conducts a reverse stock split to comply with the minimum bid price requirements. This helps them maintain their prices and allowing them to keep trading in the public market.

Companies can be delisted from stock exchanges if their prices decline significantly. A reverse split supports shares in a way that raises the per-share price that lets them stay listed on a public, accessible stock market.

As a result, more investors can buy the shares, and the existing shares maintain liquidity. While there is an issue with a reverse stock split, this strategy can help a company remain in business and bounce back from hard times over the long term.

The Impact of Stock Split

A stock split has no impact on your investment’s core value. Therefore, any major changes in the number of shares you currently have can go unnoticed.

A stock split doesn’t offer new or additional benefits to individuals who are already holding shares, nor does it change anything related to the ownership. Your shares may have doubled, but their price has been cut in half, which balances it out.

On the other hand, a stock split can urge individuals who are not yet shareholders to invest. If you were unable to buy a share of a particular company before its recent stock split, you might be able to own one now.

The opportunity for more people to invest in a stock can drive its price higher, which may fuel the company’s value over the short term.

The more investors are buying, the more demand, enabling the stock price to surge further. If you’re holding many shares, that can give you an advantage, provided that you stay invested.

Still, keep in mind that the stock and overall value boost are mostly short-lived. Typically, you need to keep holding the stock to benefit from it and observe returns in the long run.

Stock Split Impact on Fractional Investing

A few experts speculated that stock split would lose its significance as fractional share investing becomes more well-known and common. This is due to its ability to allow investors to purchase partial shares of a stock and exchange-traded funds (ETFs) at nearly any price point.

Investing apps such as HDFC Securities and legacy brokerages such as Fidelity currently let their clients own fractional shares of a particular stock and ETFs.

However, it remains largely unclear how fractional investing will affect investing and stock splits due to the lack of relevant data. Moreover, it may take a long time before fractional investing eliminates the need for stock splits.

And that’s not even taking a stock split’s psychological part into account. Research suggested that people’s minds are wired to favor round numbers. In stock investing, there is something interesting about knowing you have the financial capability to own a whole share that encourages many investors.

Stock Split: Final Thoughts

A stock split or a reverse split doesn’t carry a significant real impact on the company’s existing shareholders.

A stock split’s most significant influence is on investors who could be keeping an eye on a certain stock and expecting to buy a whole share at a discount. For them, a stock split presents an excellent opportunity to actively participate in the market.

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