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How Does a Stock Split Benefit Shareholders?

Personal Finance

If you regularly follow news on finance or the share market, you would know that several companies have announced their intent to split shares. Now if you own stock in any of these companies, what does split stock mean for you? Does your position get altered due to the split? Well, we are about to find out.

What is a Stock Split?

A stock split is when a business’s board of directors issues more number of shares to the existing shareholders without diluting the value of their stakes. In other words, a stock split increases the organization’s number of outstanding shares and drops the individual price of each share. The process does not affect the overall market capitalization of the organization as the value of every shareholder’s stake remains the same.

Let’s understand this with an example:

Say a company has issued 10,000 equity shares with a face value of INR 1,000 per share. Now the most common split stock ratio is 2:1 (i.e. 2 for 1). What this fundamentally means is that every share of the company will be split into 2. So now, instead of 10,000, your company will have 20,000 equity shares and the face value of each will come down to INR 500.

With this example, you must have understood the stock split meaning. Now, let’s get a few things clear.

  • Every company can choose a different ratio to split the stocks.
  • Regardless of the split ratio the company selects, its market capitalization does not change.
  • A stock split has a direct effect on the price of the stock. The more the company splits its stock, the cheaper it becomes.

Why Does a Company Decide to Split Shares?

In most cases, the board of directors of a company decides to split its stocks for two primary reasons:

  • The share prices have increased to a level that is too high
  • The share prices are beyond the price levels of other companies in the same sector

The main intention behind announcing a stock split is to make the shares of a company much more affordable to small investors.

That being said, sometimes, a company may initiate a reverse stock split. This is done if they believe that the stock prices are much below the average range. Also, some companies do it to avoid being delisted as many stock exchanges have a minimum share price requirement.

So, in such a 1:2 reverse stock split scenario, for every INR 1,000, you would receive 1 share instead of every 2 shares you owned as the stock prices have doubled.

How Does a Stock Split Benefit its Shareholders?

Now that you have understood the stock split meaning, it’s time to address the most significant question: how does a stock split impact its shareholders?

Well, splitting the stock offers the following benefits:

  • It makes the shares much more accessible

As discussed above, one of the main reasons why many companies opt for a stock split is high share prices. And when the share prices are very high, it can deter investors from investing.

A stock split can bring the shares in everyone’s price range. Besides, most investors will be more satisfied if they obtain 100 shares at a certain price instead of only 50. Therefore, companies can easily make their shares much more attractive and accessible to their potential investors by initiating a split stock.

  • It boosts liquidity

Another significant benefit of a stock split is that it increases liquidity. With the reduction in the share price, there is often an increased investor demand. And more demand translates to increased liquidity. In other words, shareholders can easily buy and sell more shares after a stock split.

  • It may result in increased share prices

After a split stock, your share prices have reduced. Consequently, there is an increased demand for the shares with more investors contemplating a purchase. Although fundamentally, nothing has changed, there might be increased demand. This increase in demand may lead to a future hike in stock prices, which may benefit investors in the long run.

Some Split Share Examples

A stock split is a common phenomenon and many companies have opted for it. Tesla, for instance, announced its stock split last year where each stock was split into four. In other words, it went for a 1:4 split ratio. In February 2022, Finolex brand also initiated split shares at a 1:5 ratio. Alkyl Amines Chemicals Ltd. split the face value of its equity shares, bringing the price down from Rs. 5 to Rs. 2. The move helped the company increase investor demand drastically.

Even many foreign companies have opted for a stock split. Apple, for instance, split its stock 7 times ever since it got listed on the US stock exchange.

Is Stock Split Different from Bonus Issue?

Yes, the stock split is very different from the bonus issue. You may have heard companies crediting dividends to their shareholder’s accounts. This happens when a company has an excess of cash reserves. However, sometimes, instead of distributing dividends, a company gives bonus shares to its shareholders.

The exact number of bonus shares allotted to each shareholder varies. It depends on the number of shares they presently hold. And this is called a bonus issue. Unlike the bonus issue, in the case of a stock split, the number of shares does not increase.

Wrapping Up

A split stock is typically initiated by companies that have seen their stock prices go up substantially. Splitting their stocks allows them to keep their stock prices in the optimal range while increasing affordability and accessibility for potential investors.

In most cases, stock splitting is not harmful to the shareholders. However, sometimes, these splits fail to generate good returns. So, as a shareholder, it is a good practice to keep up with the fundamentals of the company to ensure a sound investment. Visit Piramal Finance to access articles and blogs to help you learn more about a stock split.