What is a Stock Split: Why & When Companies Split Stocks?

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Equirus Wealth

01 Feb 2023 4 min read

Stock Market#Stock Market#Investment

A stock split is a corporate action in which a company increases the number of its outstanding shares by issuing more shares to existing shareholders. In other words, the company divides its existing shares into smaller denominations, making it easier for investors to buy and trade the stock. In this article, we will explore what a stock split is, how it works, why companies split stocks, what happens when a stock you own splits, what is in a stock split for investors, and what is a reverse stock split.

How Stock Split Works:

A stock split occurs when a company increases the number of outstanding shares by issuing more shares to existing shareholders. The number of new shares issued is proportional to the number of existing shares held. For example, if a company declares a 2-for-1 stock split, each shareholder will receive an additional share for each share they already own. The result is that the total number of shares outstanding doubles, while the value of each share is halved.

Why Companies Split Stocks:

Companies split stocks for several reasons, including:

  • To make the stock more affordable for smaller investors, who may not have the funds to purchase a high-priced stock. When a stock's price is high, it can be difficult for individual investors with limited funds to purchase even a single share. By splitting the stock, the company makes it possible for more people to invest in the company, regardless of their financial situation.
  • To increase the liquidity of the stock, making it easier for investors to buy and sell the stock. Increased liquidity means that there are more buyers and sellers in the market, which makes it easier to trade the stock and reduces the impact of large trades on the stock's price. This can help to reduce market volatility and improve market efficiency.
  • To boost investor confidence in the stock and attract more investors. A stock split can be seen as a signal that the company is performing well and has a strong outlook for the future. This can encourage more investors to invest in the company, which can lead to an increase in demand for the stock and, in turn, drive up the stock price. Additionally, a stock split can make the company's stock more accessible to a wider range of investors, which can help to increase its visibility and attract more investors.

What Happens When a Stock You Own Splits:

When a stock you own splits, the number of shares you hold increases, and the value of each share decreases. However, the total value of your investment remains unchanged. The only difference is that you now hold a larger number of smaller-denominated shares. For example, if you own 100 shares of a stock worth INR 100 each and the stock splits 2-for-1, you will own 200 shares worth INR 50 each.

What is in Stock Split for Investors:

A stock split is typically seen as a positive event for investors, as it indicates that the company is growing and performing well. In addition, a stock split can also make the stock more accessible to smaller investors and increase the liquidity of the stock, making it easier to buy and sell.

What is a Reverse Stock Split:

A reverse stock split is the opposite of a stock split. Instead of dividing the existing shares into smaller denominations, a reverse stock split combines multiple shares into one, reducing the number of outstanding shares. The value of each share increases proportionally. A reverse stock split is often used by companies to increase the value of their stock and attract more institutional investors, who may be more likely to invest in higher-priced stocks.

In conclusion, a stock split is a corporate action in which a company increases the number of its outstanding shares by issuing more shares to existing shareholders. Companies split stocks to make the stock more affordable and attractive to investors, boost investor confidence, and increase the liquidity of the stock. A reverse stock split, on the other hand, combines multiple shares into one, reducing the number of outstanding shares and increasing the value of each share.

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