What does split word indicate here, it means one part into two or multiple. The same happens in the stock market. Here a stock split means it increases the number of shares or stocks in our holding but the value of your holdings will not increase. In the stock split event, the shares we held get multiplied on the ratio of split. In simple terms, a stock split means splitting one stock into many. A stock split is a tool used by companies to regulate the prices of shares.
Stock split infographics by Kamlesh Rode
What is a Stock split in the stock market?
A stock split is a corporate action where the face value of existing stock is reduced in a defined ratio. A stock split of 1:4 means a split of existing stock into 4 stocks. Accordingly, the face value of a stock will go below 1\4th of the original face or price value.
If an investor holds 1000 stocks of a company with a face value of Rs.20 each, a stock split in the ratio of 1:4 will increase the number of stocks held by him to 4000 but the face value of the stock will go down to Rs.5. According to the stock company, there is no change in the stock capital with the increase of the number of stocks in the stock split.
Why do companies issue stock splits?
Stock companies consider splitting their stocks if the prices of their stocks tend to be very high which restricts the participation of the investors. As the price of a share comes down due to a split, the stock split leads to greater liquidity in the stock market.
A stock split is very much similar to a bonus resulting in an increased number of outstanding shares in the books of the company with reduced face value without any economic benefit whatsoever to the shareholders.
We can say that the stock split is also playing an important role to influence the psychology of the investors and impacting the liquidity in the stock market without any economic benefits to the shareholders.
A stock split is an action in which a company divides the face value of existing shares into a smaller face value so as to increase the number of shares proportionately.
The main intent of the company is generally to reduce the share price to make it more affordable for someone to buy.
The most common split ratios are 2-for-1 or 3-for-1, which means that the stockholder will have two or three shares, respectively, for every share held earlier.
Advantages of stock split
1. It makes the share affordable to small investors.
2. Number of shares may increase the number of shareholders; hence the potential of the investment may increase.
3. Due to the low market price of stocks there will be more trading of that stock in the market.
4. Companies has post stock split are to psychologically influence investors to buy their stock.
5. A stock split is a good buying indicator, signaling that the prices of shares of the company are increasing.
6. Investors get a higher price at the time of selling shares.
7. No additional amount is required by the investor to acquire shares as a result of a stock split.
Limitations of stock split
1. Additional expenditure needs to be incurred on the process of a stock split.
2. Low share price may attract speculators or short-term investors, which are generally not preferred by any company.
3. Number of stocks increases but the investment capital remains the same in-stock split.
4. Downsides of stock splits include increased volatility, record-keeping challenges, low price risks, and increased costs.
Understand Stock split in India with Example:
Shravan owns 1000 shares of A corporation valued at 100 rupees per share. His total investment is thus 1lac rupees.
He has just heard that B Corporation has decided to go for a stock split. A corporation has decided to increase its number of shares by issuing more shares to current shareholders.
Shravan gets one additional share for every share that he already owns. This is a one-for-one stock split, but the price of each share is now half of the previous value, that is, 100 divided by 2 equal to 50 rupees.
So, though the number of shares that Shravan owns has increased from 1000 to 2000, the total value of his investment remains the same, that is, 50 rupees into 2000 shares.
Causes for companies split their stock.
- The lower share price makes the stock more liquid, that is, easier to buy and sell.
- To make their shares more affordable to small investors.
The company’s market capitalization, that is, the total value of all its outstanding shares remains the same even after the split.
What is a reverse stock split?
A reverse stock split will reduce the number of shares you own and bump the market price by the same factor. It acts in the same way a regular stock split works but in the exact opposite way.
The total value of the investment for a stock split or reverse stock split never changes.
Wipro case study “How Rs.10000 turns into whopping Rs.1722 crores?”
Wipro Investment Growth (Stock split and Bonus)
|Year||Action||No. of Stocks||Face value(Rs.)|
|1986||Stock spilts to the Face value of Rs.10||4000||10|
|1999||Stock spilts to the Face value of Rs.2||960000||2|
In the above table if one has invested Rs.10000 in the year of 1980 today he could have 1722 crores investment. Yes, you read right. This is the power of stock split, bonus, and compounding.
In the year 1981, he received a 1:1 bonus means the number of shares gets doubled and the face value remains the same of Rs.100.
Again in the year 1985, he received a 1:1 bonus and for the following coming years investors received bonuses and stock splits period by period.
Today he has 2 crores 56 lacs stocks to his name. It means
25600000×673=17228800000(1722 Crores eighty eight lacs)
Added to this every year Wipro gives direct dividends to the shareholders.
For the last 4 years, Wipro is giving a dividend of Rs.1 every year. It means the Investor getting 2.5 crores every year without selling or liquidating the number of shares he has.
What will happen if Wipro declares a split of 1:1 then 2 crores 56 lacs stocks will get doubled? Huge profits compared to investment right!
A stock split increases a company’s total number of shares outstanding. It does not alter the firm’s market value or the proportionate ownership of existing shareholders.
Generally, a stock split is expressed as a ratio. For example, 2:1, 3:1, etc., which means that the stockholder will have two or three shares, respectively, for every share held earlier. This distribution rate will determine exactly how many shares of stock the firm hands over to its existing shareholders.
Why stock split is important in the fundamental analysis of the stock? Please read the fundamental analysis written by the stock forecast team
Frequently asked questions (FAQs)
Ans: The answer depends on how the investor carries his investment in the future. If the stock split happened then his number of shares will increase with respect to the face value declared by the stock company. It is good for long-term investment but not so bad for short-term investment.
Ans: A stock split is a corporate action where the face value of an existing stock is reduced in a defined ratio. A stock split of 1:4 means a split of existing stock into 4 stocks. Accordingly, the face value of the stock will go below 1\4th of the original face or price value.
Ans: 4 is to 1 stock means if the investor owns stock of rs.600 then after split the Rs.600 stock will split into 4 and its value will be Rs.150. The stock owners will have 4 shares of Rs.150 value.
Ans: Generally if the rising stock splits, the stock value becomes cheaper. This results in the small investor can able to purchase it. This brings a high drive at the prices of the stocks