Introduction

In the Indian stock market, there are many listed companies, both in NSE and BSE. A listed company is engaged in many corporate activities such as dividends, issuing bonus shares and many more. What does that mean when a company declares a stocks split? Is it an immediate hike in shares you held in your portfolio? Not exactly! What is Stock Split? A stocks split means the number of shares issued increases, but not the market capital. Here, it means that the existing shares will split but the fundamental value will be the same (unchanged). 

The stock market is like a bustling marketplace where shares of publicly traded companies are bought and sold. Just like how a store might offer a sale to attract more customers, companies use stock splits to make their shares more appealing. 

Let’s break down how this works!

What is a Stock Split? 

A stocks split is a corporate action in which a company increases the number of its outstanding shares by issuing more shares to its existing shareholders. The primary purpose of a stocks split is to make the stock more affordable to a larger number of investors without changing the overall value of their holdings. 

For example, in a 2-for-1 stocks split, each shareholder will receive an additional share for every share they own, effectively doubling the number of shares they hold. However, the price of each share will be halved, so the total value of the investment remains the same. If a stock was trading at ₹1,000 before a 2-for-1 split, after the split, it would trade at ₹500 per share. 

The company’s market capitalization and the value of each shareholder’s stake in the company remain unchanged.

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How Does a Stock Split Work?

In a stocks split, the number of shares increases, but the total value of the company, known as its market capitalization, remains the same. The most common type of stocks split is the 2-for-1 split, but companies can choose any ratio, such as 3-for-1, 4-for-1, or even 10-for-1.

Mechanics of a Stock Split

1. Announcement and Record Date: The company announces the stocks split and specifies the split ratio (e.g., 2-for-1, 3-for-1) and the record date. The record date is when the company identifies shareholders eligible for additional shares.
2. Ex-Split Date: This is the date when the stock starts trading at the adjusted price. On this day, the stock price is automatically adjusted based on the split ratio, and the number of shares held by each shareholder increases accordingly.
3. Stock Price Adjustment: The stock’s price is adjusted proportionally to reflect the split. For instance, if the stock was trading at ₹1,000 before a 2-for-1 split, the price would be halved to ₹500 after the split. 
4. Increase in Shares: Shareholders receive additional shares according to the split ratio. In a 2-for-1 split, every shareholder gets one additional share for every share they own, doubling their total number of shares. For example, if you owned 100 shares before the split, you would own 200 shares afterwards.
5. No Change in Market Capitalization: The company’s market capitalization (the total market value of number of shares outstanding) remains unchanged. This is because the increase in the number of shares is offset by the proportional decrease in the share price.

Why Companies Perform Stock Splits?

• Increased Liquidity: By lowering the share price, stock splits make the stock more affordable for a broader range of investors. This can increase the liquidity of the stock, meaning it is easier to buy and sell.
• Psychological Appeal: A lower share price can make the stock appear more attractive to retail investors, even though the value of the company hasn’t changed.
• Signal of Confidence: Companies sometimes use stock splits as a signal of confidence in future growth. A split might indicate that the company expects its stock price to continue rising, even after the split.

Example of a Stocks Split

Let’s consider a practical example:

• Before the Split: Suppose a company has 1 million shares outstanding, each trading at ₹1,000. The market capitalization would be ₹1 billion (1 million shares * ₹1,000).
• 2-for-1 Stocks Split: The company announces a 2-for-1 stocks split. After the split, there will be 2 million shares outstanding. However, the stock price will be adjusted to ₹500 per share.
• After the Split: Now, each shareholder owns twice as many shares as before, but the price per share is halved. The total market capitalization remains ₹1 billion (2 million shares * ₹500).

Types of Stock Splits

Stock splits can be broadly classified into two categories:

1. Regular Stock Split
2. Reverse Stock Split

1. Regular Stock Split

A regular stock split (also known simply as a “stock split”) is the most common type of stock split. In this scenario, a company increases the number of its outstanding shares by issuing additional shares to existing shareholders. The value of each share is proportionally reduced so that the total value of the shareholder’s investment remains unchanged.

Example:

2-for-1 Stock Split: If a company announces a 2-for-1 stocks split, it means that for every one share an investor holds, they will receive one additional share, effectively doubling the number of shares. If you owned 100 shares priced at ₹1,000 each before the split, after the split, you would own 200 shares priced at ₹500 each. Your total investment value remains ₹100,000 (200 shares * ₹500).

Reasons for a Regular Stock Split:

• Make Shares More Affordable: By lowering the stock price, the company makes its shares more accessible to a wider range of investors.
• Increase Liquidity: A lower share price can lead to increased trading volume and higher liquidity, making buying and selling the stock easier.
• Positive Market Perception: A stock split can signal the company’s confidence in its future performance, which might attract more investors.

2. Reverse Stock Split

A reverse stock split is the opposite of a regular stocks split. In this case, a company reduces the number of its outstanding shares by consolidating multiple shares into one. The price per share is increased proportionally, so the total value of the shareholder’s investment remains the same.

Example:

1-for-2 Reverse Stock Split: If a company announces a 1-for-2 reverse stock split, it means that for every two shares an investor holds, they will receive one share in return. If you owned 200 shares priced at ₹50 each before the split, after the split, you would own 100 shares priced at ₹100 each. Your total investment value remains ₹10,000 (100 shares * ₹100).

Reasons for a Reverse Stock Split:

• Avoid Delisting: Companies may perform a reverse stocks split to increase their share price to meet minimum listing requirements on stock exchanges. For example, a stock price that has fallen too low might risk delisting from a major exchange, so the company consolidates shares to boost the price.
• Improve Perception: A higher share price can improve the market perception of the company, making it appear more stable or valuable, even though the actual market capitalization remains unchanged.
• Attract Institutional Investors: Some institutional investors have rules preventing them from investing in stocks below a certain price threshold. A reverse stock split can make the stock more appealing to these investors.

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Key Differences Between Regular and Reverse Stock Splits

• Objective: A regular stocks split aims to reduce the stock price to make it more accessible, while a reverse stocks split increases the stock price, often to avoid delisting or to improve market perception.
• Outcome: In a regular stocks split, the number of shares increases, and the price per share decreases. In a reverse stocks split, the number of shares decreases, and the price per share increases.
• Market Perception: Regular stock splits are usually seen as positive, indicating growth and confidence. Reverse stock splits, on the other hand, may be seen as a sign of weakness, as they are often used by companies trying to prevent their stock from falling below critical levels.

How to Calculate a Stock Split?

Here is a step-by-step guide on how to calculate the effects of a stock split:

1. Understand the Split Ratio

The split ratio indicates how many new shares each existing share will be converted into. Common ratios include:

• 2-for-1: Each share splits into two shares.
• 3-for-1: Each share splits into three shares.
• 1-for-2: In the case of a reverse stocks split, every two shares combine into one.

2. Calculate the New Number of Shares

To find out how many shares you will have after the stocks split, multiply your current number of shares by the split ratio.

Formula:

• New Number of Shares = Current Number of Shares x Split Ratio

Example (Regular Stocks Split):

Suppose you own 100 shares, and the company announces a 2-for-1 stocks split.

After the split, you would have:

• 100 x (2/1) = 200 shares

Example (Reverse StocksSplit):

Suppose you own 200 shares, and the company announces a 1-for-2 reverse stocks split.

After the split, you would have:

• 200 x (1/2) = 100 shares

3. Calculate the New Stock Price

The price per share is inversely affected by the stocks split. To find the new stocks price, divide the current stock price by the split ratio.

Formula:

• New Stock Price = Current Stock Price / Split Ratio

Example (Regular Stock Split):

Suppose the stock price is ₹1,000 before a 2-for-1 split.

After the split, the new stock price would be:

• ₹1000/2 = ₹500 per share

Example (Reverse Stocks Split):

Suppose the stock price is ₹50 before a 1-for-2 reverse split.

After the split, the new stock price would be:

• ₹50 / (1/2) = ₹100 per share

4. Verify the Total Investment Value

Even though the number of shares and price per share change, the total value of your investment remains the same before and after the split.

Formula:

• Total Investment Value = New Number of Shares x New Stock Price

Example (Regular Stocks Split):

Using the previous examples, if you owned 100 shares at ₹1,000 each, your investment was worth:

• 100 x ₹1,000 = ₹100,000

After the 2-for-1 split, you would own 200 shares at ₹500 each, and your investment would still be worth:

• 200 x ₹500 = ₹100,000

Example (Reverse Stocks Split):

If you owned 200 shares at ₹50 each, your investment was worth:

• 200 x ₹50 = ₹10,000

After the 1-for-2 reverse split, you would own 100 shares at ₹100 each, and your investment would still be worth:

• 100 x ₹100 = ₹10,000

Benefits of Stock Split Shares

• Increased Liquidity: A stocks split lowers the share price, making the stock more affordable to a wider range of investors, which often leads to higher trading volume and improved liquidity.
• Broader Investor Base: By reducing the price per share, a stocks split makes the stock accessible to more retail investors who might have been unable to afford higher-priced shares.
• Positive Market Perception: A stocks split is often viewed as a sign of confidence from the company, suggesting that it expects continued growth, which can enhance investor sentiment.
• Improved Marketability: A lower stock price post-split can attract more buyers, making the stock more marketable, especially among smaller or individual investors.
• Potential for Index Inclusion: In some cases, stock splits can help a company qualify for inclusion in certain stock market indices, which often have specific price criteria, leading to increased demand from index funds.

Conclusion

A stock split is a strategic decision made by a company to make its shares more accessible and liquid without affecting its overall market value. While it doesn’t change the intrinsic value of an investor’s holdings, it can lead to increased trading activity and potentially greater investor interest.

Whether you’re new to investing or a seasoned pro, understanding stock splits can help you plan your financial future in a much better way. 

So next time you hear about a stocks split, you’ll know exactly what it means and how it can impact your investments! If you are new to the stock market, wait no further! 

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