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What is a Stock Split?
A stock split is when companies divide their existing shares into multiple new shares. Usually, the goal with stock splits is to decrease stock prices and boost liquidity. Usually, companies use multiples to increase their shares outstanding. For example, companies may use 3-for-1 or 4-for-1 stock splits. It means that they will convert each share that shareholders own to 3 or 4 shares.
While companies may use a stock split to reduce their share prices, it does not affect their overall valuation. Therefore, stock splits do not impact a company’s shareholders’ total equity or their wealth. Instead, it aims to increase the number of shares that a company has in circulation in the market.
How does a Stock Split work?
Stock splits are prevalent among publicly traded companies. Companies usually grow in size due to their past performances, new acquisitions, new product, or share repurchases. This growth in size brings various benefits for the company, such as an increased share price in the market. However, some investors may not be able to purchase their shares at higher prices.
Therefore, companies announce stock splits. As mentioned, companies used multiples for stock splits. For example, a company using a 2-for-1 stock split will double its total number of outstanding shares. If the shares were worth $10 each before the split, their value becomes $5 after. Shareholders will have the same worth of shares before and after the process. However, the number of shares will differ.
Investors who couldn’t afford a company’s shares at $10 may be able to afford it at half the price. For the company using the stock split, it opens up more sources of finance. That is why it is most common among large companies that want to increase their share liquidity.
What are the advantages of Stock Splits?
The most beneficial consequence of stock splits is that it makes a company’s shares more liquid. It doesn’t only benefit new investors looking to purchase the company’s shares. It also helps the existing shareholders by allowing them to dispose of their holding easily. It also makes it easier for portfolio managers to rebalance their portfolios.
Unlike reverse stock splits, stock splits can actually result in higher share prices in the future. It is because the reduced prices increase the demand for a company’s shares. The increased demand, in turn, increases the company’s share prices. Most companies have experienced a growth in share prices after announcing stock splits.
Is Stock Split good or bad?
Stock splits can be good if used properly. However, most experts believe that they are bad. Firstly, stock splits decrease a company’s share prices. Doing so attracts retail investors and may discourage quality investors from investing in a company. Similarly, stock splits could increase volatility in the market because of the new share price. While an increased demand in a company’s stock can increase its share prices, it also makes it more volatile.
Lastly, stock splits don’t always result in increased prices. These can lead to risks that investors or the market may view the split as a negative signal. Thus, it can also result in a decrease in a company’s share prices in the market.
Conclusion
Companies use a stock split to divide their existing shares into multiple new shares. It allows them to boost their share’s liquidity. Stock splits are the most common among large companies. These can be advantageous and can increase a company’s share prices in the future. However, stock splits may also be bad as they cause volatility. They also bring low-quality investors.
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