Stock split

Definition

A stock split is a corporate action in which a company divides its existing shares into multiple shares.

What is a stock split?

A stock split effectively increases the number of shares available in the market while reducing the price of each share proportionally. The total market capitalisation (value of the company) remains the same. Here are some key points about stock splits:

1. Increase in Number of Shares:
   • In a stock split, each existing share is divided into multiple shares. Common splits include 2-for-1 (each share becomes two shares), 3-for-1, or other ratios.
2. Proportional Reduction in Share Price:
   • As the number of shares increases, the price per share decreases proportionally. For example, in a 2-for-1 split, if a share was priced at £100 before the split, it will be priced at £50 after the split.
3. Maintains Total Market Value:
   • The total market capitalisation of the company (the total value of all shares) remains the same after a stock split. The split does not affect the overall value of investors’ holdings.
4. Liquidity and Accessibility:
   • Stock splits can make shares more affordable to a wider range of investors. This can potentially increase liquidity and trading activity.
5. Psychological Impact:
   • Stock splits are often perceived positively by investors. Some may see it as a sign of confidence from the company’s management in the future prospects of the business.
6. No Impact on Company’s Financials:
   • A stock split does not change the fundamentals of the company. Earnings, assets, and liabilities remain the same on a per-share basis.
7. Fractional Shares:
   • In some cases, investors may receive fractional shares if the split doesn’t result in a whole number of shares. Brokerages may offer the option to cash out these fractional shares.
8. Reverse Stock Splits:
   • In contrast to a regular stock split, a reverse stock split combines a certain number of existing shares into one share. This is often done by companies to increase the price per share, which can attract different types of investors.
9. Regulatory Considerations:
   • Companies must comply with regulatory requirements and obtain necessary approvals before implementing a stock split.
10. Communication with Shareholders:
    • Companies typically announce a stock split well in advance and provide information to shareholders about how the split will be executed.

Stock splits are a strategic decision made by companies to manage the price of their shares and potentially make them more accessible to a broader range of investors. They do not alter the intrinsic value or financial position of the company.

Example of a stock split

Company: ABC Corporation

Before split:

• Total shares outstanding: 1,000
• Stock price: £100 per share

ABC Corporation announces a 2-for-1 stock split. This means that for every one share an investor owns, they will receive two shares after the split.

After split:

• Total shares outstanding: 2,000 (1,000 shares x 2)
• Stock price: £50 per share (£100 / 2)

In this example, ABC Corporation’s stock split results in doubling the number of outstanding shares while halving the stock price. The overall value of the investor’s holdings remains the same before and after the split.