Stock Split : Why Do Companies Split The Stock ...??

Hi friends,

When it comes to stock split, people get confused about how a stock split works, do I need to pay for it, why the share price is dropped after the stock split, and why there is a sudden drop in price after the stock split. This includes everything about the stock split and how it impacts shareholders as well as the company.

What is a stock split?

A stock split is a corporate action in which a company issues more shares to the shareholders in the proportion of shareholders holding. When a company declares a split in the ratio of 2:1, it means shareholders will get 2 shares for every 1 share. After the stock split, the existing share is divided into extra shares without any extra burden on shareholders. 

Why company will do a stock split?

  1. The main purpose of a stock split is to increase the liquidity of shares by increasing the number of shares.
  2. The company chooses to do a stock split to decrease the ticket size of shares. It helps to increase the liquidity of shares. If the ticket size of a stock is large, people avoid large ticket size stock, and liquidity decreases.
Types of stock split

  1. Forward stock split:
    • After the stock split, the number of outstanding shares increases. 
    • Example: 2:1 stock split. Shareholders will get 2 shares for every 1 share held.                                
  2. Reverse stock split:
    • In this case, the number of outstanding shares decreases after a reverse stock split.
    • Example: 1:5 reverse stock split. In this case, shareholders will get 1 share for every 5 shares held. 

                

Impact of stock split on a company:

  1. Share price decreases in the proportion to the stock split. If the stock split ratio is 2:1, the price will be halved after the split.
  2. The number of outstanding shares increases.
  3. Liquidity increases due to an increase in the share capital of the company.
  4. There are no changes in the company's total net asset value.
  5. The dividend per share decreases as the number of total shares increases.
  6. Earning per share decreased due to an increase in the number of shares but profit remains the same.
  7. The face value of the company decreases as per the stock split ratio.

Example of stock split: 2:1, 3:1, 5:1,10:1

2:1 stock split:
It means shareholders will get 2 extra shares for every one share held. 
If you have 100 shares of a company at a share price of 1500 Rs with a face value of 10. In that case, you will get 200 shares after the stock split.

Total investment before stock split = 100 * 1500 = 150000/-
Total number of shares after stock split = 200 
Share price after stock split = 1500/2= 750/-
Total investment after stock split = 200 * 750 = 150000/-
Face value after stock split = 10/2 = 5

5:1 stock split:
It means shareholders will get 5 extra shares for every one share held. 
If you have 100 shares of a company at a share price of 1500 Rs. In that case, you will get 500 shares after the stock split.

Total investment before stock split = 100 * 1500 = 150000/-
Total number of shares after stock split = 500 
Share price after stock split = 1500/5= 300/-
Total investment after stock split = 500 * 300 = 150000/-
Face value after stock split = 10/5 = 2

Note: If you see it carefully, total investment remains the same before and after the stock split, face value decreases, and the number of outstanding shares increases. 

Eligibility for stock split
You should be a shareholder of the company on the record date. To be eligible for a stock split, shareholders need to buy shares before the ex-date. (Read more: What is the Record date & ex-date?) 

Impact of stock split on shareholders:
  1. The number of shares increases in the proportions of shareholders holding, but total investment remains the same.
  2. There is virtually a drop in profit and loss in holding due to stock split adjustments. Once extra shares get credited into account, profit & loss will be adjusted accordingly.
  3. Investments of shareholders remain the same so there is no gain or loss in shareholders' investments.
Stock split vs bonus issue (Read more: What Is Bonus Issue?):
  • Face value decreases in the proportion of stock split but face value remains the same in case of bonus issue
  • Reserves decreases in the proportion of bonus issue as share are paid out from reserves cash but there are no changes in reserves in case of a stock split.
  • All other parameters remain the same for stock split as well as bonus issues. 
Summary:
  • A stock split is a multiplying or dividing of outstanding shares.  
  • Face value changes due to stock split.
  • The stock split is a corporate action. It doesn't have any impact on the market value of the company as well as on shareholders' investments.
  • Stock split helps to attract more people due to lower ticket size.

Stay Tuned☺
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