What is Stock Split ?
All publicly-traded corporate have a set of shares that is outstanding on the stock market. A stock split is a decision by the company’s board of directors to increase the number of shares that are outstanding by issuing more shares to current stockholders. For example, in a 5-for-1 stock split, every stockholder with one share is given 5 extra shares. So, if a corporate had 10 million shares outstanding before the split, it will have 50 million shares outstanding after a 5-for-1 split.
A share’s price is also affected by a stock split. After a split, the share price will be reduced in proportion to ratio of stock split so market capitalization will be same after stock split, because though the number of shares outstanding increases, the price of stock decreases in the same proportion because no actual value has been added as a result of the split so market capitalization will be same.
A stock split is usually done by companies that have seen their share price increase to levels that are either too high or are beyond the price levels of similar companies in their sector. The primary reason is to make stock seem more realistic to small investors even though the underlying value of the company has not changed, because there is a tendency among retail investors that higher the price of stocks,chances of it increasing is low and lower the price higher the chance of it increasing so if you tell anybody to buy a 1$ dollar stock he will buy and if you tell to buy a 100$ stock he will say its too expensive while in realty that both stocks may be of same value but due to lower price of first one investor will buy that rather than a higher priced stock. Hence due to stock split there is more marketability and liquidity in the market for the stock.
Stock split reduces the EPS (earning per share) of company because number of share increase without any increase in profit of company so it is not liked by existing shareholders. For the same reason some companies goes for reverse split which is exact opposite of stock split in it shares outstanding decreases and price rises accordingly in same proportion and hence in it also market capitalization remain the same but it leads to increase in EPS due to less number of shares and same profit so for example in a reverse 5-for-1 split suppose there are 50 million stocks outstanding of 5$ will become 10 million and price will be 25$ and hence the market capitalization will be same.
Hence from the above it can seen that stock split is done by corporate for various reasons and investor should look into various other factors and not only the price of stock before investing in any stock which from the above can increase or reduce due to stock splits.
Related posts:
