Investment word of the day: Stock split — why do companies opt for it?
Investment word of the day: Listed companies opt for various corporate actions to address the interests of shareholders, increase profitability or for corporate restructuring. One such corporate action is a stock split.
What is a stock split?
A stock split is a corporate action that occurs when a company issues additional shares to shareholders, typically to boost liquidity as the price of the shares decreases after the split. The total number of shares issued is increased by a specified ratio based on the shares held previously. However, the total value of the investment remains the same.
Stock split — an example
If a stock with a face value of ₹20 undergoes a 2:1 stock split, the face value of the share decreases from ₹20 to ₹10. Hence, the number of shares owned doubles with a stock split, while the total investment value remains the same at ₹20.
How does a stock split work?
During a stock split, the existing shares of the company are divided into multiple shares in accordance with the ratio announced by the company. After the split, the number of shares increases, making it affordable for shareholders. However, there is no change in the total value of the shares, as a stock split does not add any value.
Shares are distributed equally to the shareholders according to their present holdings. Hence, with a stock split, they own more shares at a lower price. The stock is split in various ratios, such as 10:1, 5:1, 2:1, or 3:1. The ratio of the stock split will typically depend on the company’s goal.
Why do companies opt for a stock split?
Listed companies generally opt for a stock split to increase liquidity and provide accessibility to stocks. With a stock split, the company tries to lower the price of a share, making it affordable for investors. By lowering the price of a share, companies aim to increase trading volumes and motivate investors.
Disclaimer: This article is for informational purposes only and does not constitute financial advice; please consult a qualified financial advisor before making any financial decisions.
