What is the Purpose of Stock- Split and Their Benefits? Why Do Stocks Split?

What is a Stock- Split

The decision on ‘Stock split’ is taken by companies primarily when they believe that the prices of its share have reached such a stage that it no longer remained attractive or out of reach to the buyer, or beyond the price level of similar companies in the same sector. Stock split is a process to make its shares more affordable. The Stock split has many other names like bonus issue, scrip issue, free issue, capitalization issue.

The most important thing to know on the issue of a stock split is that the market capitalization or net worth of a company remains unchanged in spite of the increased or additional number of shares. What really happens is similar to exchanging one $100 bill for two $50 bills, total money value remains same.

 Why Do Stocks Split / What is the Purpose of a Stock Split

The first reason for a stock split should be psychology. If the price of a commodity gets higher and higher the investors may feel it is unaffordable.

Splitting of stocks bring the stock to an affordable level.

Stock split is a logical way to bring liquidity that increases with the number of increase in shares. A stock split gives nothing additional to the stakeholders; just his number of stocks is increased.  The following diagram clearly depicts a good illustration of stock split.

 

 

Pre split

 

Post split

 

2 For 1 Split

Number of shares

Share price

 

10 million

$100

 

20 million

$50

3 For 1 Split

Number of shares

Share Price

 

1 0million

$100

 

30 million

$33.33

Market Capitalization

Remained unchanged under both the circumstances

$1000 million $1000 million

 

Stock Split Benefit

When the price of share gets too high it scare off small investors, splitting stocks bring them at a reasonable level.

By reducing value per share through stock split, trading volume goes up because more number of shares becomes available at a lower price tag.

Investors feel stock split as a buying signal that the stock is doing well.

There is another split of stock reverse to ‘stock split’ known as ‘reverse split’, where the company reduces the number of outstanding shares in multiple and the per share price rises accordingly.

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