Stock split broadens investor base of company

Ashish Gupta, ET Bureau

 
 

 
 

A stock split is the partitioning of outstanding shares of a company into a larger number of shares, without affecting stockholders' equity or the total market value of the stock.

 
 

For example, if a company declares a 2-for-1 stock split of its stock, which has a current market value of Rs 100 per share, and 1,00,000 shares are outstanding

Before the split:

 
 

Outstanding shares: 1,00,000

Market value: Rs 100

Market capitalisation: Rs 1 crore

 
 

After the split:

 
 

Outstanding shares: 2,00,000

Market value: Rs 50

Market capitalisation: Rs 1 crore

Essentially, in the 2-for-1 stock split, the company's outstanding shares are simply doubled and the stock price is divided in half. The market capitalisation, or market value of the stock, remains the same. This is because stock splits have no impact on the value of a company's stock.

 
 

A stock split is merely an accounting transaction in which no equity is exchanged. Companies can split their stock in any number of ways. These splits occur in different combinations (2-for-1, 3-for-1, 3-for-2, 5-for-4, etc).

 
 

When a company declares a stock split, the price of the stock will decrease, but the number of shares will increase proportionately.

 
 

For example, if you own 100 shares of a company that trades at Rs 100 a share and it declares a two-for-one stock split, you will own a total of 200 shares at Rs 50 a share after the split. A stock split has no effect on the value of what shareholders own. If the company pays a dividend, your dividends paid per share will also fall proportionately.

Companies often split their stock when they believe the price of their stock exceeds the amount smaller individual investors would be willing to pay. By reducing the price of the stock, companies try to make their stock more affordable to these investors.

 
 

Usually, stock splits have a positive affect on the stock price. Over the long term, stock splits seem to have a considerable effect on the company's stock price. Although stock splits have no direct effect on a company's equity, the event of a split does forecast hints and signs of how the company is performing. Companies usually tend to split their shares when they have an optimistic view of their future and operations.

 
 

The announcement of a stock split can be a symbol that a stock has attained a certain level of success. The fact that a company has a record of multiple stock splits usually indicates that the company is among one of the faster growing firms, since their stock has been split numerous times.

 
 

Generally, a company is motivated to split its stock to attract more investors with a lower share price. Many investors would rather buy a stock at Rs 200 per share than at Rs 2,000 per share even though the cost basis will be identical

However, some investors can only buy lower-priced stocks because they may not have the buying power to make a larger investment.

 
 

Thus, they wait until a stock splits so they can afford some shares. Just because a company declares a stock split, it does not mean that the stock price will inevitably rise in reaction.

 
 

There are many other variables that influence investor decision in the event of a stock split including economic reports, market stability, earnings, interest rates etc.

 
 

Companies also split their shares if they need to broaden their shareholder base and make more shares available to investors. A motivation for this could be a company's defence to a potential hostile takeover. Stock splits make the company more liquid, allowing more investors the opportunity to purchase an ownership in their company

What are the key dates important to investors?

The two key dates that are important to investors are the announcement date and the payment date. The announcement date is important because no one knows for sure if and when a company a will declare a split of their stock. Thus, investors speculate on whether a company will announce it and when it will announce it.

 
 

The payment date is crucial as well because this is the day before the company actually splits its share price, after which investor activity changes as the new share price targets a different audience.

 
 

Also, companies tend to try to keep their stock within a certain price range. Therefore, when a stock hits the company's price target, the company, upon approval of the Board of Directors and the shareholders, will announce a stock split.

 
 

A stock split simply involves a company altering the number of its shares outstanding and proportionally adjusting the share price to compensate. This in no way affects the intrinsic value or past performance of your investment, if you happen to own shares that are splitting