What is Stock Split: Definition, Reasons & Example
Stock split is a term used often in the stock market. So, what exactly is a stock split? It is the division of existing shares into multiple shares. To increase the number of outstanding shares, companies use a stock or share split. Here’s an example of a stock split.
For example, if the firm whose shares you have decides to do a 3 for 1 stock split, you will receive 3 shares for every 1 share you own as a shareholder. So, if the corporation had 10,000 outstanding shares before the split, it will now have 30,000 outstanding shares. but The company’s market capitalization would stay unchanged.
Reasons for Stock Split
Let’s look at the reasons for the stock split
One of the main reasons for the stock split is Liquidity. Often, a company’s share price is too expensive for investors to buy, and any additional rise in pricing will stop them from participating. The shares of a stock are made accessible to all by decreasing the value of the stock through a split.
Increase the number of stockholders
The number of outstanding shares of a corporation increases as a result of a stock split, allowing additional investors to purchase shares. This contributes to a company’s investor base growing.
Future Growth Expectations
Companies that split their stock are seen as developing businesses. Investors believe that if a company splits its shares, it is planning to grow, and this notion is correct.
Effects of Stock Split
Let’s look at the effects of the splitting now that the meaning and reasons are obvious.
With a stock split, the number of stocks in your portfolio of a specific firm is multiplied according to the decided ratio. The earning per share is affected by the split ratio. If the split ratio is 2:1, for example, earnings per share will be cut in half.
Multiply the number of shares you already have by the number of new shares issued for each existing share
Stock Split Formula
Multiply the number of shares you already have by the number of new shares issued for each existing share For example, if the company in which you own 150 shares opts for a 2:1 split, you will receive 300 new shares (150×2).
Apply the formula below to determine the price of a share after it has been split in half:
Old share price/Stock split ratio = new share price
The new price of the share would be 100 /(3:1), which equals 33.33 if the stock’s last trading price was 100 and the stock split was 3:1.
Advantages of Stock Split
One of the most significant benefits of a stock split is that it can result in significant profits. A stock’s price may rise as a result of a share split, which indicates greater performance. According to studies, stocks that have been divided have proven profitable for investors.
What exactly is Stock Split Reverse?
A reverse stock split is an exercise in which an entity reduces the total number of outstanding shares by a certain multiple while increasing the share price by that multiple. For example, if you have 10 shares of 200 each and the company decides to do a reverse stock split of 1:2, you will end up with 5 shares of 400 each.
How Does a Stock Split Reverse Work?
The reverse stock split works in a variety of ratios, including 5:1, 10:1, and even more. It is up to the company how they want to go about it. It should be noted that the exercise is performed on a specific date known as the record date. The merged shares will begin trading after this date.
Reverse Stock Split Example
Assume that the company whose stock you own announces a one-for-one reverse stock split. So, if you own 100 shares, it will be converted into one share. If you own 1000 shares of the company at the current price of 10, before the stock split, the price would be 10,000. (1000 x 10).
Following the reverse stock split, you will have 10 shares valued at $1,000. The total price of ten shares is fixed, i.e. 1000. As a result, the exercise has no effect on a firm’s market capitalization.
Reverse Stock Split Benefits
The reverse stock split mechanism assists a company in recovering from losses and avoiding the negative consequences of delisting. Several stock prices have risen in the past after this exercise. It can raise the price of a share in the short term.
The reverse stock split allows you, the investor, to trade with greater liquidity. Following this exercise, the psychological value of shares increases with a higher value.
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