What Are Stock Split?

Stock split

Stock split is a strategy employed by some companies to draw in investors. It occurs when a company decides to increase its number of shares outstanding to the public. There are two important events that happen when companies split their stocks. First, the company’s share price decreases, second, the number of shares available for purchase increases. Overall, the market capitalization of the company remains the same.

Apple Inc. announced back in June 2014 that it would be splitting seven-to-one (7:1) in the stock market. In other words, one share would become seven. As a result, their outstanding shares grew to 6 billion, from approximately 861 million. Additionally, the stock price dropped from $649.88 to $92.70 per share.

In the same vein, on the 1st of February 2022, Alphabet announced a 20-for-1 stock split. The stock split will be implemented on the 15th of July 2022.

How Do Companies Split their Stocks?

Anytime a company announces it will split its stock, it is usually because of one of two reasons. Either the company is growing and making progress or declining and struggling. Typically, companies employ two methods of stock splitting: the conventional or forward stock split and the reverse stock split.

The Conventional Stock Split

In a conventional stock split, the number of shares available for public purchase is often increased. An increase in shares reduces the stock price but leaves the market cap value unchanged. A company’s market cap is determined by multiplying the number of shares outstanding by the share price.

The Reverse Stock Split

As implied in the name, the reverse stock split is the inverse of a conventional split. Here, a company reduces the number of its shares available in order to raise the stock price. Some companies do this to appear strong when their stock price is too low. A low-priced stock is in danger of being delisted from the stock market.

Why Do Companies Split their Stocks?

Impression of Affordability: Stock splits are usually done by companies that experience tremendous growth. Because of this growth, their stock price has become too high for small investors to afford. Let’s assume Jay was considering buying Apple stock (AAPL) in February 2014. Since Jay only had $100 to invest, he couldn’t afford to buy it for $650. Later in June, when Apple split their stock, small investors like Jay could afford to own a share.

Despite the perception of affordability, the market cap value of the stock does not change. It can be compared to splitting a $100 bill into ten $10 bills. The new price perception might encourage investors to join the company.

Liquidity: While many financial gurus argue that stock splitting does not increase a company’s liquidity, others disagree. Short-term upward movements always occur when a company first announces its plans to split stocks. Ultimately, a stock’s success depends on the results the company produces.

Perception: It has been observed that companies on the verge of failure usually opt for a reverse stock split. Many exchanges may delist stocks when their price falls below a certain level on the stock market. To appear more substantial, these companies inflate their stock price.

The Benefits of a Stock Split

Loyalty: Big companies like Nike or Apple split their stock to make it attractive to small investors who are regular consumers. Since these small investors own a small portion of the company, they remain loyal to the brand.

Removes Entry Barrier: A stock split removes a significant barrier to entry and makes shares more accessible to the public. An affordable stock is an incentive for potential investors. Additionally, many investors joining a company could increase the company’s liquidity.

The Drawbacks of Stock Split

Invites the Wrong Set of People: Many investors, like Warren Buffett, believe that dividing stocks will attract small investors who have a short-term focus on profits. Conversely, an expensive stock will probably attract investors in it for the long haul.

Value: Smaller investors have a common misconception that price is proportional to value. Because of this belief, many investors buy after a company announces plans to split its stock. This concept is false because stocks are divided to decrease the price but not increase value.

It May Be Unnecessary: Stock splitting may be unnecessary, since many stock exchanges now allow investors to buy fractionally, regardless of how high a stock’s price is.

Final Thought

In the long run, stock splits are not a reliable way to assess a company’s progress. While conventional splits are a helpful way to attract new investors, reverse splits are usually a sign of impending doom.

Get market insights and stock recommendations from Horao to help you get a head-start in long-term investing. CLICK HERE TO SIGN UP NOW

Tags :
stock,stock market
Share This :
Latest posts by Olasoji Amujo (see all)