Throughout their course of operation, companies often undertake various corporate actions that can affect their financial structure and stakeholders. These actions may involve dividend payouts, rights and bonus issues, mergers and acquisitions, stock splits, and more. One such corporate action that numerous companies undertake is a stock split.

During FY22-23, 111 companies chose to undergo a stock split. You can read this blog further to understand better what a stock split entails. 

What Is A Stock Split?

A stock split is a corporate action wherein a company divides an existing shareholder’s single share into multiple shares, thus increasing the number of outstanding shares while maintaining the same market capitalization. 

During a stock split, the total investment amount of an investor remains the same while the value of an individual share decreases. For instance, if a company undergoes a 2-for-1 stock split, every shareholder will receive two shares for each share they previously owned.

Let us understand this with an example: suppose you own one share of a company valued at ₹2000 per share. Post stock split, you will have two shares, each worth ₹1000. Thus, the company’s outstanding shares will increase while its market capitalization will remain unchanged.

What Is A Reverse Stock Split?

As the name suggests, a reverse stock split is a corporate action wherein a company merges multiple shares held by existing shareholders into a single share. This way, the company reduces the number of outstanding shares while maintaining its market capitalization. During a reverse stock split, the total investment amount of an investor remains the same while the value of an individual share increases.

For instance, if a company undergoes a 2:1 reverse stock split, every shareholder will receive one share for every two shares they previously owned.

Let us understand this with an example: suppose you own one share of a company valued at ₹1000 per share After the reverse stock split, you will have a single share worth ₹2000. Thus, the company’s outstanding shares will decrease while its market capitalization remains unchanged.

Why Do Companies Split Their Stocks?

Companies perform stock splits when their stock prices have increased by a good amount . Although an increased stock price is a positive indicator for a company, the stock may become less affordable for investors. Hence, companies go for a stock split to make their stock more affordable and attractive to numerous retail investors. This also improves liquidity and creates better bid-ask spread.

For instance, you may not be able to afford a stock worth ₹1000 per share. However, that stock may look more attractive when you can buy five shares worth ₹200 per share, thereby investing ₹1000.

Why Is Reverse Stock Split Done?

  • After a correction, sometimes the stock trades at too low prices. The reverse stock split allows companies to improve their stock price in such cases.
  • Some exchanges have minimum stock price requirements. To meet these requirements, a stock may go through a reverse stock split.

Advantages Of Stock Split

Here are certain benefits of a stock split

For companies:

  •  New investors may get attracted to buy the stocks due to increased affordability after a stock split.

For investors:

  • After a stock split, the value of an individual share reduces, making it more affordable for investors to purchase additional shares of the stock.
  • Existing investors can enjoy increased flexibility and liquidity when trading their shares after a stock split. Additionally, investors can sell some of their shares while retaining others.

What Happens When A Stock Splits?

  • After a stock split, the number of shares an investor holds increases while the investment amount remains the same.
  • Selling part of the holding or buying more shares into the portfolio becomes easier after a stock split.
  • Due to the increased number of shares after the stock split, there can also be short-term volatility in the stock’s price.

Stock Split Companies

Here are some examples of stock split companies.

  1. In September 2005, ITC (India Tobacco Company Limited) underwent a stock split, changing its face value from ₹10 to ₹1. Each stockholder received 10 stocks for every 1 stock of ITC after the stock split.
  2. In September 2019, HDFC underwent a stock split, which changed its face value from ₹2 to ₹1.

Is Stock Split Good Or Bad?

Determining whether a stock split is always beneficial or detrimental is difficult to answer with certainty. Typically, investors view it as a positive development in the near term, but the effects tend to level out over time.

Final Thoughts

A stock split is a corporate action wherein companies divide their shares, decreasing their per-share value. This can be an advantageous time for investors seeking to acquire a previously unaffordable stock. Nevertheless, purchasing a stock solely based on its reduced price is not advisable. Instead, investing in stocks that align with your investment objectives is recommended.

FAQs

Should I buy before or after a stock split?

There is no guarantee of definite returns whether you purchase a stock before or after a stock split. If the stock seems expensive, waiting for the split to occur can reduce the share price. However, investors generally view a stock split in a positive light. As a result, those who buy the stock before the split may also see significant returns.

What are the disadvantages of the stock split?

Stock splits can have a notable drawback: the potential for price fluctuations in the stock after the split. Moreover, the stock split process may entail significant legal and administrative expenses for companies.

Do stocks typically go up after a split?

While there are no guarantees that stocks will experience an increase in value after a split if the stock performs well and investors are optimistic about its prospects, the likelihood of an upward trend following the split may increase.

Do stock splits make you richer?

It’s important to note that stock splits don’t automatically result in quick wealth for investors, as the total investment amount remains unchanged even though the number of shares increases.