The American Yankee legend Yogi Berra once said, “You better cut my pizza into four slices because I’m not hungry enough to eat six.” But the taste of the pizza will, however, remain the same irrespective of how many pieces you cut it into, isn’t it? That’s essentially what a stock split means.
Whether you are an experienced investor or just starting out in the world of finance, let’s start with the basics. In this blog post, we will discuss what they are, why companies split stocks them, and how they can impact your investment strategy.
Let’s begin demystifying this essential concept in the stock market, shall we?
What is a Stock Split?
Split share means a corporate action that enables a company to break and divide its existing shares into multiple new shares where each investor’s stake and market capitalisation (total value of the common shares owned by a stakeholder) remains unaffected.
A company splits its stock using a specific split ratio to determine how many shares it will be divided into. The stock split can be in the form of a forward or reverse stock split.
Let’s understand this concept through an example. Suppose you have invested in Company X. Now, the company has announced a split in a 2:1 ratio with a stock price of Rs.100, and you go from having Rs.100 shares for one stock to two stock shares of Rs.50 each. Here, the stock split effect doesn’t affect the overall market cap. This is an example of a forward split where the investor got two shares at a lower price.
|Number of stocks before the split
|Price per share of stocks before the split
|Number of stocks after the split
|Price per share of stocks after the split
Upcoming Stock Splits in 2024
Wondering if you should invest in companies that have announced stock splits?
Tis the season, my friend.
We have prepared a list of companies that have announced their share split for February 2024. Refer to the table to understand better.
|Remedium Lifecare Ltd
|SG Mart Ltd (Formerly known as Kintech Renewables Ltd)
|Maagh Advertising & Marketing Services Ltd
|HDFC Index S&P BSE ETF
|HDFC Nifty Banking ETF
|HDFC Nifty IT ETF
|HDFC Nifty Private Bank ETF
How Does a Stock Split Work?
Meghan Railey, a certified financial planner and Optas Capital’s co-founder recalls stock splits as ‘when a company wants to change their per-share prices while making the stocks more accessible to people.’ Existing shareholders receive additional shares when a company issues them, increasing their total shares by a specified split ratio, i.e. usually 2:1 and 3:1. Companies choose to split their stocks to lower their share trading prices and offer a more affordable range to investors.
Many investors would like to invest in 100 shares of Rs.1000 stock rather than buying one share of Company X at Rs. 1000. So, the board of directors of a company decides to introduce a stock split when their share prices rise. The board of directors can choose any split ratios like 2:1, 3:1, 5:1, 10:1, or 100:1 etc. A 3-for-1 represents that for every share you hold in Company X after the stock split, you’ll own three.
Why Do Companies Split Stocks?
It also indicates that a company is thriving, which is a good thing, but the management decides to split their stocks as they believe that their share prices are relatively ‘high’ or above the ‘optimal’ share trading range. As a result, companies may do it to make their stocks look more enticing to investors.
A stock split example, Amazon Inc. carried out the famous stock split at a 20:1 ratio on June 3, 2022. This represents that any investor holding at least one share in Amazon Inc. until May 2022 will own 20 shares. On 3, 2022, before Amazon went into split effect, each share was traded at Rs. 2,447; after the split, each share was Rs.122.35. However, an additional 19 shares were also added to the investor’s demat account.
What Happens When a Stock is Split?
One of the main benefits of splitting a stock is to make a company’s share cheaper for budding or low-risk appetite investors.
Although stock splits can be beneficial since they increase the number of outstanding shares during the split, the total dollar value price remains the same because splitting stocks doesn’t add real value. When a split is implemented with a specific split ratio, the price of a share is automatically adjusted in the market on the stock exchanges (like NASDAQ, NYSE, BSE, NSE, etc).
Let’s walk you through a classic example. Suppose Company A has ten thousand outstanding shares available at Rs.60 per share. Company A’s board of directors announced a stock split of 2:1.
Two investors, Tara and Lara, had a stake in the company before the split was announced. Tara owns 6% (or 600), and Lara owns 2% (or 200) of the outstanding shares. When the split was announced, Company A instantly increased the number of its outstanding shares. So, now both of these investors owned twice the outstanding shares, i.e. 20 thousand.
Thus, after the split, Tara owns 1200 shares at a 6% stake, and Lara owns 400 shares at the same 2% stake.
(Note: When existing shares of stocks are split 2-for-1, their price is roughly halved, so even though there are 100% more shares, each has a 50% lower value.)
Factors That Can Impact the Investors During a Stock Split
Now, let’s look at some of the factors that can impact investors.
- Changes in the Number of Shares Held: When a company does a stock split, the number of shares held by an investor changes, but the total value of their investment remains the same. This means that the investor’s ownership percentage in the company remains the same, but the number of shares they hold and the price per share change.
- Effects on Share Price: A share split can temporarily impact a company’s share price. In a forward stock split, the price per share will reduce proportionally. Consequently, making the stock more affordable to investors and increasing demand.
- Impact on the Value of an Investment: As mentioned earlier, a stock split only changes the number of shares held and the price per share. The total value of the investment remains the same, assuming there are no other changes in the stock price.
- Tax Implications of a Stock Split: Since the total value of the investment remains the same, there is usually no immediate tax liability resulting from a stock split. Thus, the cost basis of each share is adjusted accordingly, which can affect the calculation of capital gains or losses when the shares are sold.
Types of Stock Split
There are two main types of stock splits that companies can use to increase the number of outstanding shares. Let’s understand together.
What is a Forward Stock Split?
A forward stock split is the most common type of stock split. In this type of split, a company increases the number of outstanding shares by dividing each existing share into multiple shares. For example, in a 2-for-1 stock split, each existing share splits into two new shares. As a result, the total number of shares outstanding is doubled, but the value of each share is halved
Before the split:
|Type of Stock
|Number of Shares
|Price Per Share
|Total Value of Shares
After a 2-for-1 split:
|Type of Stock
|Number of Shares
|Price Per Share
|Total Value of Shares
What is a Reverse Stock Split?
This is the opposite of a forward stock split. In this type of split, a company reduces the number of outstanding shares by combining multiple shares into one share. Let’s understand through a reverse stock split example. For example, in a 1-for-5 reverse stock split, every five existing shares of stock are combined into one new share. As a result, the total number of shares outstanding is reduced by a factor of five, but the value of each share is increased proportionally.
Before the reverse split:
|Number of Shares
|Share Price (Rs)
|Total Market Cap (Rs)
After the reverse split:
|Number of Shares
|Share Price (Rs)
|Total Market Cap (Rs)
How Do Stock Splits Affect Short Sellers?
Contrary to what you might expect, stock splits generally don’t have a significant impact on short sellers in terms of their overall position or potential profit/loss. However, there are some adjustments that happen due to the split:
Changes in Position
- Number of Shares: After the split, the short seller will owe a proportionately higher number of shares compared to before. For example, a 2-for-1 split on 100 shorted shares would result in owning 200 shares after the split.
- Share Price: Conversely, the price per share will decrease proportionally to the split ratio. In the same example, the Rs. 100 per share price would drop to Rs. 50 after the split.
Impact on Profit/Loss Potential
- Overall Value: Importantly, the total value of the short position remains the same before and after the split. In the example, the short position was worth Rs. 10,000 before the split (100 x Rs. 100) and remained at Rs. 10,000 after the split (200 x Rs. 50).
- Cost of Closing: Although the position value remains unchanged, the cost of closing the short position might change depending on the price movement after the split. If the price continues to fall, the short seller can benefit from buying back the shares at a lower price. However, if the price rises, the cost of closing the position will increase, reducing the potential profit.
Is a Split Good for a Stock?
Share splits, in general, are neither good nor bad. A stock split is takes place when companies want to make their stock look more attractive so investors can buy it. However, as mentioned above, it is usually a good sign that the company is growing and is open to future growth prospects.
Should You Invest in a Share After Stock Split?
Before 1999, SEBI only permitted two face values – Rs. 10 and Rs. 100. Nowadays, the split ratios can vary for different companies, such as 2:1, 10:1, or 5:1.
Recent studies suggest that there has been a negative impact on wealth following stock split announcements post-1999, thereby refuting the signaling hypothesis. However, an examination of the top 30 companies from 2001 to 2010 revealed that exactly half of the stock splits resulted in positive returns during the one-year period following the event. Conversely, the remaining stocks yielded negative returns. Another analysis dismisses the trading range hypothesis, as most stock splits are announced for stocks already trading at low prices.
Impact of Stock Splits Among Investors
Once a split is announced and implemented in the market in a specific split ratio (including reverse split like 1:3 or 1:2), it doesn’t affect your investment value. However, if the company issues cash dividends to its existing shareholders, it will also issue a record date.
As stated in the above-mentioned example, Tara and Lara will hold the same stake in Amazon Inc., i.e. 6% and 2%, respectively, irrespective of the stock split.
However, in the long run, investing in a portfolio of stocks rather than one stock is always advisable because why hunt for a needle when you can have the whole haystack?
What are the Advantages of a Stock Split?
Splitting stocks by a company can provide several advantages for the company as well as its shareholders. Here are some of the most significant stock split advantages are:
- Increases Liquidity: A split increases the number of shares outstanding and can increase the stock’s trading volume. This higher volume of shares traded can increase liquidity and make it easier for investors to buy or sell the stock.
- Attracts New Investors: A lower share price after a split can make the share more accessible to a wider range of investors whom the high price may have previously deterred. This can increase demand for the stock and attract new investors, which can drive up the stock price.
- Improves Perceived Affordability: A stock split can create a perception of affordability among investors. For example, some investors may view a company’s stock that trades at Rs.1,000 per share as unaffordable. However, after a 2-for-1 stock split, the same company’s stock will be trading at Rs.500 per share, making it more accessible to investors.
- Increases Market capitalisation: A share split can result in more outstanding shares, increasing the company’s market capitalisation. This could attract institutional investors who may have previously been unable to invest in the company due to its low market capitalisation.
What are the Disadvantages of a Stock Split?
While a split can provide several advantages, there are also some potential disadvantages of stock split that companies and investors should consider as well. Here are some of the most significant disadvantages of a share split:
- No Change in Company Value: A stock split does not affect the underlying value of a company. The company’s market capitalization, earnings, and fundamentals remain unchanged before and after the split.
- Volatility: A share split can increase the stock’s volatility, which may lead to wider bid-ask spreads and higher volatility for short-term traders.
- Perception of Financial Difficulty: In some cases, a company splitting its stock can be perceived as a sign of financial difficulty or a lack of confidence in the company’s future performance. This perception may negatively affect the stock price and investor sentiment.
Example of Stock Split
Let’s take an example of a Company X where the original share price is Rs. 1,400 and split ratio is 2:1.
Before the Split:
- An investor owns 10 shares of Company X at Rs. 1,400 each.
- Total investment: 10 shares x Rs. 1,400/share = Rs. 14,000
After the Split:
- The investor receives 2 additional shares for each existing share, resulting in a total of 10x 2 shares = 20 shares.
- The share price is adjusted to reflect the split ratio, becoming Rs.1,400 / 2 = Rs. 700 per share.
- The investor’s total investment remains the same: 20 shares x Rs. 700 = Rs. 14,000
Are Stock Splits Important with Widespread Fractional Share Investing?
As fractional investing gains more popularity and widespread adoption, some experts speculate that the significance of stock splits may diminish, given that fractional shares enable investors to buy into a company at nearly any price point.
According to Holden, assessing the impact of fractional investing on stock splits is challenging due to limited available data. He notes, “It’s challenging to predict how fractional investing will influence the need for stock splits, but I believe it will be a considerable amount of time before fractional investing completely eliminates that necessity.”
Moreover, the psychological aspect of stock splits should not be overlooked. Holden emphasizes that the human preference for round numbers plays a role, stating, “Investors are often motivated by the satisfaction of knowing they possess the funds to buy a whole share.”
What is a Basket Order?
A basket order is a type of order that allows you to buy or sell multiple securities at the same time in a single go. Think of it like a shopping cart for your investments. You can add different stocks, bonds, or other assets to your basket and then submit the order all at once.
To Wrap It Up…
To conclude, in a stock split, each investor’s stake and market capitalisation remains unaffected. So, a stock split won’t affect your stake, but it will affect your shares if you buy before or after the split.
Hence, it’s better to invest in a basket of stocks on smallcase or do portfolio investing, in which our top-notch analysts recommend portfolios that reflect your interests. In just a few clicks, you can create, share, and track your smallcase with friends and family. Isn’t that amazing?
Start your investment journey with smallcase today!
A stock split is a corporate action where a company decides to divide its existing shares into multiple shares. This results in an increase in the number of outstanding shares while proportionally reducing the share price.
A stock split ratio indicates the proportion by which a company divides its existing shares. For example, in a 2 for 1 stock split, shareholders receive two shares for each one held.
Well, a stock split is neither inherently good nor bad. It increases the number of shares while decreasing the price per share proportionally, aiming to make the stock more accessible.
The stock split benefits are improved liquidity, reduced share price, increased accessibility for retail investors, and a potentially positive impact on market perception.
Purchasing before a split may involve buying at a higher per-share price, but it results in owning more shares post-split. Buying after a split could be more cost-effective, offering the potential for the stock to appreciate.
Splits are often a bullish sign since valuations get potentially high, and the stock may be inaccessible for smaller investors aiming to maintain diversification. Investors holding a stock that undergoes a split may not make a lot of money immediately. However, it’s advisable not to sell as share split can be a positive sign.
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