What is a Stock Split?

A stock split is a corporate action undertaken by an entity to divide the existing shares into multiple new shares in order to boost liquidity. Although, the number of shares outstanding increases, the total value of the portfolio pre-split and post-split remains unchanged.

A Stock split is done by a publicly-traded company. When a company decides to go for a stock split, the number of shares outstanding (shares issued by the company) increases without any change in the market capitalization. Technically, no new shares are issued to the shareholders. A stock split simply increases the number of shares held by an investor and decreases the Face Value of the individual stock, without any dilution in the value of the investment.

For Example, you purchased 10,000 shares of XYZ company at a face value of Rs. 10 in the year 2019. In 2020, the company announced a split in the ratio of 2:1. This means that for every share held, the shareholder will receive 2 shares. So, the total number of shares held by you post-split will be 20,000.

Now, coming to the value of your investment, initially, you were holding 10,000 shares of XYZ company with a Face Value of Rs. 10 each. So, your total investment value was Rs. 1,00,000/-. Now, post-split (say in the ratio of 2:1), the number of shares held by you increases to 20,000, and the Face value of the share gets reduced to Rs. 5 per share. The total value of the investment post-split is still Rs. 1,00,000/-

Therefore, the stock split simply changes the number of shares held without dilution in the investment. The shareholder doesn’t pay anything to the company in a stock split. Recently, there was a stock split for shares of Affle (India) Limited in the ratio of 5:1. This means that against 1 equity share of the Face Value of Rs. 10, the shareholders received 5 equity shares of Face Value of Rs. 2 each.

Why company’s do stock splits?

When the share price of a company increases to levels that are too high, the company decides to do a stock split. The stock split can result in shares becoming more affordable to small investors, thereby increasing liquidity. When a company announces a stock split, the share price may go down initially. But, as the stock becomes more affordable, the increase in demand may drive the price up. Many times, a stock split provides a signal to the market that the stock price is increasing and the growth is likely to continue in the future. This might increase the demand for the shares and thus increase the price.

Is Stock split positive?

A stock split is often a positive sign. The valuation of the company’s stock grows very high and is out of the reach of small investors. Hence, to create liquidity, increase marketability, and make the shares affordable to a larger number of small investors, the company announces a stock split.

What is a Reverse Stock Split?

A Reverse stock split is done when the company decides to decrease its outstanding shares with an increase in the price of an individual share. A company usually goes for a reverse stock split to consolidate the shareholder base.

Whenever a stock split/reverse stock split takes place, just analyze the reason behind it and decide your course of action. Buying a stock, simply based on stock splits/reverse stock split announcement might not be a wise idea. One needs to understand the business model, track record, financials, and future prospects of the concern. If the stock is available at the right price, then an investor can decide on adding it to his/her portfolio.

However, keeping track of the stock split is good as it might give an opportunity to existing/new investors, to add a blue-chip stock to their portfolio at an attractive price.