What is Stock Split
A stock split is a very common term in the stock market. A stock split is a process to divide existing shares into multiple shares.
Companies basically do stock split in order to increase their outstanding shares.
for e.g. let’s suppose you hold shares of ABC company and the company decides that it will split the stock into 2. So, that means every share you hold will be converted into 2.
Now, the company had 1 lakh outstanding shares before the stock split so the total outstanding shares will be 2 lakh.
But the market capitalization of the company will stay the same
It means that the price of 1 stock you used to hold earlier will now be the same price of two stocks. There will be no change in the overall value of the stock, just its quantity will be increased and the price of the share will be reduced.
Reason/Benefits for Stocks Split?
- Increase Liquidity – The primary reason for splitting the shares is to increase liquidity in stocks.
What happens sometimes the company’s share price is too high for investors, So if the share price rises further, it may discourage investors to buy the shares.
Hence, by splitting the shares, its price is reduced and it is made accessible to all. - Increase Stakeholder Base – In stock split company’s outstanding shares are increased and it gives an opportunity to more investors to buy the company’s shares and also increases the stockholder base.
- Image of Future Growth – Companies that take stock split decisions are seen as a growing business. So there is a gerneral perception in the mind of investors that the companies that split the stocks have good growth planning.
The formula for Calculating Stock Split
So to calculate how many shares you will own after a stock split
For example, if you hold 200 shares of ABC company and the company’s stock split ratio is 2:1 then, it means instead of 1 share, the company is issuing 2 shares.
And to know what will be the new price of the share after the share split
we will use this formula:
New share price = old share price/stock split ratio
if we take the case of our example, then it will be simple 400/2:1.
Shares at Rs 200 will be the new price.
What is Stock Split Reverse
Just the quantity of shares is increased in a stock split, a reverse stock split is an exercise.
In which the company reduces its total number of outstanding shares and the share price also increases in the same way.
And there is no change in the market capitalization of the company.
For e.g. if you have 20 shares of a company whose price is Rs 500 per share
the company does a stock 1:2 stock split, So after this, you will have 10 shares and the price will be Rs 1000 per share.
This exercise is done on a particular date called the record date.
Benefits of Reverse Stock Split
This machanism helps company to recover from its losses and protect itself from delisting on stock exchanges
In the past the prices of many other stocks has seen to be increased suddenly after this exercise, in the short term it can increase the price of the share.
You may refer to this video if you want the explanation in Hindi
