Stock Split

What is a Stock Split?

A stock split is a corporate action in which a company increases the number of its outstanding shares by dividing its existing shares into multiple shares. The overall market value of the company remains the same, but the number of shares outstanding and the price per share change.

Stock Split Defined

During a stock split, the company’s board of directors decides on the ratio for the split. Common ratios include 2-for-1, 3-for-1, or even higher multiples.

For example, in a 2-for-1 stock split, each existing share is split into two, effectively doubling the number of outstanding shares.

What Happens with Stock Splits

  1. Increase in Outstanding Shares: The company increases the number of shares outstanding, but the proportionate ownership stake of existing shareholders remains the same. For example, if an investor-owned 100 shares before a 2-for-1 split, they would own 200 shares after the split.
  2. Adjustment of Share Price: After the split, the price per share decreases proportionally to maintain the company’s total market capitalization. For example, if the stock price was $100 per share before the split, it would become $50 per share after the 2-for-1 split.
  3. Liquidity and Accessibility: Stock splits can make shares more affordable for individual investors, potentially increasing liquidity and trading activity in the stock. This increased accessibility may attract more investors to the company’s shares.

Benefits of Stock Splits

  1. Existing Shareholders: Existing shareholders benefit from a stock split as they receive more shares without additional investment. While the price per share decreases, the total value of their investment remains the same. Stock splits can also make shares more liquid and tradable, potentially attracting more investors.
  2. Market Perception: Some investors perceive stock splits as a positive signal from the company, indicating confidence in future growth prospects. This positive sentiment can increase demand for the stock, potentially driving up its price over time.

Stock Split Example

Let’s say Company ABC’s stock trades at $200 per share and announces a 2-for-1 stock split.

Before the split:

    • Number of shares outstanding: 1,000,000
    • Stock price: $200
    • Market capitalization: $200,000,000

After the split:

    • Number of shares outstanding: 2,000,000
    • Stock price: $100
    • Market capitalization: $200,000,000 (remains the same)

After the split, existing shareholders would receive one additional share for each share they own, and the stock price would decrease to $100 per share. However, the total value of their investment would remain unchanged, and the company’s overall market capitalization would remain the same.