What is a Stock Split?

What is a Stock Split?

A stock split is a corporate action where a company increases the number of shares by reducing the face value of the stock. Companies generally split shares to increase liquidity, since the price of the stock reduces after the split.

A split increases the number of shares by decreasing the face value, but the total value of the investment remains the same. The split shares will be credited within a week.

The most common split ratios are 2-for-1 or 3-for-1 (sometimes denoted as 2:1 or 3:1). This means for every share held before the split, each stockholder will have two or three shares, respectively, after the split.

A stock split is when a company increases the number of its outstanding shares to boost the stock’s liquidity.

Although the number of shares outstanding increases, there is no change to the company’s total market capitalization as the price of each share will split as well.

The most common split ratios are 2-for-1 or 3-for-1, which means every single share before the split will turn into multiple shares after the split.

A company elects to perform a stock split to intentionally lower the price of a single share, making the company’s stock more affordable without losing value.

Why Do Companies Engage in Stock Splits?

When a company’s share price increases to a nominal level that may make some investors uncomfortable, or is beyond the share prices of similar companies in the same sector, the company’s board may decide on a stock split.

A stock split can make the shares seem more affordable, even though the underlying value of the company has not changed. It can also increase the stock’s liquidity.

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When a stock splits, it can also result in a share price increase—even though there may be a decrease immediately after the stock split. This is because small investors may perceive the stock as more affordable and buy the stock.

This effectively boosts demand for the stock and drives up prices. Another possible reason for the price increase is that a stock split provides a signal to the market that the company’s share price has been increasing; people may assume this growth will continue in the future. This further lifts demand and prices.

Reasons for Stock Splits

Why would a company want to double or triple its outstanding stock shares if its market capitalization won’t be affected?

There are a number of reasons for stock splits. However, there are two that are most common. The first has to do with perceived company liquidity. With each share’s price dropping a certain percentage – depending on the ratio that the company decides to use – investors tend to see the company’s stock as more affordable, and therefore may be more likely to buy shares. The lower the share price, the less risky the stock seems.

A stock split makes the stock more affordable for more investors and thus can be used to draw in new investors who may have been reluctant or simply unable to purchase the stock at its higher, pre-split price.

The move is a useful strategy when a company’s stock price rises to a level that prices many investors out, or when the price has risen significantly higher than its competitors’ stock.