A stock split is an action in which a company divides its existing shares into multiple smaller shares keeping the market capitalization same. The shares do no dilute because of a stock split.
Why a stock split?
A company generally announces a stock split to make it cheaper to buy and thereby making it more affordable for a small retail investor. This not only increases the demand of the stock but also provides the company with liquidity(or cash in hand).
A stock split has the following impacts on the company’s postition.
- Market Capitalization remains the same.
- Demand for stock increases.
- Share price: First decreases then start to increase.
- No. of Outstanding Shares increases.
- Earning Per Share and Dividend decrease.
Example 1: A company ABC whose value of each share is $30, it announces a stock split such that value of each share is 1/3rd the value of its original price. The company does so by dividing the value of one stock by three. Therefore, the value of each share will become $10, and the sum of three such stocks will be $30 thereby keeping the value held by the investor constant.
- Let us assume that you hold 100 shares of Reliance Industries (RIL). Each share of RIL costs Rs. 1000. Therefore, you hold shares worth Rs. 100,000 in total.
- Let us also assume for convenience that the total number of outstanding shares is 1,000,000(1 Million) and therefore market capitalization will be 1,000,000,000 (1 Billion).
- One fine day RIL announces a stock split of 1-for-1(One share More for every One outstanding share), this means that the total number of outstanding shares will be 2,000,000(2 Million) but the market capitalization still remains 1 Billion at the moment.
- Now when RIL announce the stock split the number of shares you had held also doubled but their total value still remained the same i.e. Rs.100,000 but the value of each share that you hold will be half i.e. Rs.500 (Rs.1000 divided by 2).
- After this, you can expect a decline in price due to the excess supply of shares in the market post which the price will surge due to increased demand thereby raising liquidity for the company.