Table of Contents
Meaning of a stock split
A stock split is when a company increases its number of shares by reducing the face value per share. Though the number of shares increase, the market capitalization remains the same as a stock split does not change the value of the company. Stock splits generally happen in a specified ratio. For example, if a stock split is announced in the ratio of 1:10, it means for every 1 share held, the investor will get 10 shares. A stock split boosts the liquidity of the company’s stock as it is more affordable after the split.
How stock split works?
The rationale behind a stock split is that people are more comfortable buying an affordable share. People would buy a Rs 1,000 share more comfortably than buying a Rs 10,000 share. The face value of Rs 10 is split to Rs 5, Rs 2 or Rs 1. These are the most common stock split denominations. Companies opt for a stock split if the stock price has increased significantly over the years. A stock split helps to increase the investor base of a company. As mentioned earlier, the value of the company remains unchanged after a stock split.
Example of stock split
Let us understand stock split with an example. Suppose stock price of ‘John Black Ltd’ today is Rs 16,000 per share. The Company has issued 100 shares to investors till date. Now the Company announces a stock split in the ratio of 1:10. This means for every 1 share held, the investor will get 10 shares.
Tara owns 5 shares of Company ‘John Black Ltd’. The market value of her investment is Rs 80,000 (16000 x5). After the stock split is complete Tara will own 50 shares. The market value of her investment will still remain Rs 80,000. However the per share price will now reduce to Rs 1,600 (80,000/50).
Jeet always wanted to buy stock of ‘John Black Ltd’ but could not afford it. Post the stock split, the market price of the stock reduces to Rs 1,600. Now the stock becomes affordable for Jeet and he buys 100 shares of the Company.
For John Black Ltd, the issued capital before stock split was Rs 16,00,000 (16,000 x 100). After the stock split the issued capital remained Rs 16,00,000. However the number of shares in the market increased to 1,000 (100 x 10). So for the company, only the number of shares increased. The value of the company did not undergo a change.
Advantages & Disadvantages of stock split
| Advantages | Disadvantages |
| Makes a stock more affordable | Increases volatility in stock prices |
| Increases liquidity | Stock split issue is expensive and lengthy process |
| Increases investor base |
What is a Reverse Stock Split?
A reverse stock split is the opposite of a normal stock split. In a reverse stock split the company reduces the number of shares and increases the share price proportionately. The market value of the company remains the same even in case of a reverse stock split.
