When a company’s share price is too high or too low, it might choose between a stock split and a reverse stock split. A stock split can assist a company in decreasing its share price to attract new investors. However, a reverse stock split can help the company increase its share price and maintain its listing on a major stock exchange. Continue to read this article to find more information.
List of Contents
What Exactly Is a Stock Split?
When a business divides one share of its stock into many shares, this is known as a stock split. For instance, a business may divide one share of stock into two shares. The aggregate value of the two new shares is still equal to the old share’s price. For example, if company A completed a two-for-one stock split and the original share price was $40, the new shares would be valued at $20. Thus, an investor who previously owned 50 shares at the original price of $40 would now have 100 shares at the revised price of $20.
Working Principles of a Stock Split
A stock split is appropriate for publicly traded companies, including blue-chip stocks worth billions of dollars. Due to acquisitions, new product releases, or share repurchases, the value of the companies increases. At some point, the reported market value of the stock becomes unaffordable for investors, which begins to impact market liquidity as fewer and fewer individuals can purchase shares.
Assume company A, which is publicly traded, announces a two-for-one stock split. Before the split, you had 100 shares valued at $70, for a total of $7,000. Your total investment value remains the same after this event, at $7,000, because this divisor reduces the stock price. Thus, $70 becomes $35 after the two-for-one split. After the split, you would own 200 shares priced at $35 each. Therefore, the total value of your investment would remain unchanged at $7,000.
The Causes and Effects of Stock Splits
Causes
When businesses consider that their stock price is excessively high relative to comparable companies’ stock prices, they frequently elect to split their shares. Furthermore, this event decreases the price of a company’s shares. Thus, this makes it more affordable for smaller investors to acquire shares. This increases the stock’s liquidity. The flexibility of buyers and sellers is increased by liquidity. It also implies that even when trading volume is great, it may have little effect on the price of a stock. Significantly, enhanced liquidity can also reduce trade slippage during share repurchase activities.
Effects
Theoretically, a stock split does not affect the value of a company’s stock. With this event, you receive additional shares at a reduced price per share. However, your net investment value remains the same. However, following a stock split, the price of the shares may increase. This is because smaller investors can now afford the stock when formerly they could not.
In addition, it can also signal to the market that a company’s share price has been increasing. Investors may purchase shares if they consider this a favorable indicator of the company’s future. Each stock split is unique. The price of a company’s shares may rise after this event, although this is not always the case.
Pros and Cons
Pros
- Frequently boost the stock price
- Make selling put options less costly
- Facilitate portfolio rebalancing
- Boost liquidity
Cons
- Not all stock splits result in price increases
- Could heighten volatility
Reverse Stock Splits
A reverse stock split is what it sounds like: the opposite of a traditional one. It occurs when a company combines its shares into fewer, more valuable shares instead of dividing them into a larger number of shares with a lower price. In a 1-for-2 split, for instance, 10 million $1 per share shares would become 5 million $2 per share shares.
Typically, companies engage in reverse stock splits when they consider that the price of their shares is too low. If a company’s stock price falls below a specific threshold, it may be delisted from an exchange. It is one technique to avoid this. Following it, the company’s overall market capitalization is the same as after a traditional one. Nevertheless, if you want to know more about reverse stock splits, you can continue to read this article.
Conclusion
In short, a stock split, or even a reverse stock split, has little influence on a company’s present stockholders. The greatest impact of it is on investors who may be monitoring a specific stock in the hopes of purchasing a complete share at a lower price. A stock split may be a significant incentive for these investors to enter the market.
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Read more: Stocks
Source: The Balance