WHAT IS STOCK SPLIT

Stock splits are among the most common corporate actions in India and worldwide. A stock or share split reduces a stock’s par value. For example, reducing the par value of the stock from ₹10 to ₹5 is a 2:1 stock split and reducing the par value from ₹10 to ₹1 is a 10:1 stock split. Having understood the meaning of the stock split, let us detail what a stock split is.

Stock splits are normally done to reduce the market price of the stock and bring it into a more popular range. All stock splits and share splits are value-neutral in that they do not impact the company’s value in any way. Let us understand this and share a split story with an example.

Particulars	Pre-Stock Split Data	Post Stock Split Data
The ratio of stock split at 10:2	Old face value of the stock – ₹10	The new face value of the stock – ₹2
Number of shares outstanding	5 crore shares	25 crore shares
Total Net Profit of the company	₹55 crore	₹55 crore
Earnings per share or EPS	₹11	Rs2.20
Price-earnings ratio or PE ratio	25 times	25 times
The intrinsic value of the share	₹275 per share	₹55
Stock price	₹280	₹60
Market capitalization	₹1,400 crore	₹1,500 crore

In the above illustration, if you are a shareholder, your shareholdings are up 5 times, but your price is down to approximately one-fifth. That means the impact is almost marginal. That is why it is said that the stock split is value-neutral. However, there is an important point to note. When a high-priced stock is split, the price comes into a more popular range, so more retail investors get interested in the stock, and this higher demand takes the price higher. However, in terms of the company’s valuation, the stock split is still valued neutral.

To cut a long story short, investors who own stocks still have the same amount of money invested in a stock split, but now they own more shares at a proportionately lower price. However, as we saw above, the value may not exactly be the same, and normally, the stock split tends to make the stock more valuable due to its wider reach. That is one of the most popular reasons companies do a stock split.

How Does a Stock Split Work?

A stock split is a corporate action that increases the number of a company’s outstanding shares while proportionally reducing the share price. This process is primarily designed to adjust the share structure without affecting the overall market capitalization of the company. 

The process begins with the company’s board of directors approving a stock split. They determine the split ratio, such as 2-for-1 or 5-for-1, which indicates how many new shares will be issued for each existing share. For example, in a 2-for-1 split, shareholders will receive two shares for every one share they currently own.

Once the stock split is executed, the share price is adjusted according to the specified ratio. For instance, if a company’s stock was trading at ₹200 before a 2-for-1 split, it would adjust to ₹100 per share after the split. If an investor owned 100 shares at ₹200 each (totaling ₹20,000), they would now hold 200 shares at ₹100 each, maintaining their total investment value.

After the distribution date, brokers automatically credit the new shares to shareholders’ accounts based on their holdings prior to the split. This adjustment is seamless for investors who see an increase in their share count without needing to take any action.

Understanding Stock Split Ratio

A stock split is a corporate action that increases the number of shares outstanding while proportionally decreasing the share price, leaving the overall market capitalization unchanged. The split is executed based on a specific split ratio, such as 2:1 or 5:1. This means that for every share an investor holds, they receive additional shares according to the ratio. For example, in a 2:1 stock split, an investor with one share at ₹100 would now hold two shares at ₹50 each, maintaining the total investment value of ₹100.

The main objective of a stock split is to make shares more affordable and accessible to a wider array of investors. When a company’s stock price becomes high, it may deter potential investors. By splitting the stock, companies can lower the per-share price, thus increasing liquidity and potentially attracting more buyers. This is particularly beneficial for retail investors who may prefer purchasing multiple shares at lower prices rather than a single high-priced share.

Stock splits can occur in various ratios, including 3:1, 5:1, or even higher. Each ratio indicates how many new shares will be issued for each existing share. For instance, in a 10-for-1 split, an investor holding one share would now have ten shares, and if the pre-split price was ₹1,000, the post-split price would adjust to ₹100 per share.

It’s important to note that while stock splits can enhance market activity and investor sentiment, they do not alter the fundamental value of the company or its assets. The total investment value remains constant before and after the split; only the number of shares and their respective prices change.

Why Do Companies Use Stock Split?

Companies use a share split in India because it makes their shares relatively cheaper and more appealing to a wider investor base. Highly-priced shares from any company make it expensive for most retail investors, resulting in lower marketability and liquidity. A share split increases the outstanding shares and proportionally lowers the share price. 

For instance, if the share price of an organization touches ₹2,000, a share split can bring it down to ₹400 per share so that more investors can be attracted. Along with new investors who may have been discouraged by high prices, trading activity may pick up. 

A lower price can also give an impression that the shares are low-priced and have growth potential and this will attract more investors. Companies may also use share splits to remain in an exchange listing, such as the NSE or BSE, with minimal pricing requirements.

Types of Stock Splits 

The different types of splits are as follows –

1. Regular Stock Split : 

In the case of a regular share split, the company expands its number of shares with decreased price per share. The common type is two for one or three for one. For example, in the split 2-for-1, a shareholder will get one more share for every share she or he already holds. Therefore, if an investor owns 100 shares at ₹500 per share before splitting, he will have 200 shares at ₹250 share price value after splitting. The overall wealth will be the same, ₹50,000 in the end. Regular share splits are common among companies whose share prices have risen significantly and look to enhance liquidity by lowering the price per share.

2. Reverse Stock Split:

A reverse share split consolidates shares to increase the price per share. The companies whose share prices are low and at the risk of getting delisted from the exchanges adopt it. For instance, in a 1-for-5 reverse share split, five shares will be exchanged for one new share. If an investor had 100 shares at ₹10 before the split, then after the share split, he would get 20 shares priced at ₹50 each. Share price increases but reduces the total number of outstanding shares. Companies can use reverse share splits to enhance their market image or to fulfil minimum listing requirements on the stock exchange.

3. Special Stock Split:

Some companies could do special share splits to reward shareholders as part of a corporation’s overall strategy. These share splits might be structured and intended to benefit shareholders in different forms, but their general impact is to raise shareholder values or to indicate confidence in possible growth.

How Does a Stock Split Affect You?

A stock split directly affects your investment by increasing the number of shares you hold while lowering the price per share without any change in the overall investment value. For instance, if you held 100 shares priced at ₹500 before a 2-for-1 split, you will hold 200 shares priced at ₹250 after the share split. That adjustment does not change your percentage ownership in the company or its overall market capitalization.

However, there is a potential upside to share splits. A lower share price may attract more investors, increase demand, and potentially drive up the stock price over time. This heightened interest may lead to improved liquidity in trading, making buying or selling shares easier when desired.

It is worth noting that although a share split can positively boost investors’ perception and increase trading activity, it does not alter the fundamentals or financial health of the company. Therefore, as an investor, this is a critical reason for continuing to assess the company’s performance and the market environment beyond the impact of the share split.

Key Dates in a Stock Split 

The key dates related to a share split are:

• Announcement Date: This is the date when the company announces its decision to do share splits.
• Record Date: The date that decides who, among the shareholders, will receive additional shares.
• Effective Date: This is the date when the trading is based on the new number of shares, and the prices are adjusted accordingly.

Advantages of a Stock Split

There are four ways in which a stock split is valuable to investors.

1. Stock splits improve liquidity. Liquidity improves when a high-priced stock is split and brought into a more popular trading range.
2. Stock splits make portfolio rebalancing easier since lower-priced stocks are more liquid and easier to sell and churn.
3. This is more psychological, but the stock split reduces the risk for an option buyer optically as the option premiums come down.
4. If not all the cases, stock splits tend to be price accretive in most cases due to improved liquidity.

Disadvantages of a Stock Split

While the share splits have plenty of benefits, there are quite significant disadvantages. They do not create real value. Stock splits merely play around with the number of shares and their prices while actually changing neither the overall market capitalization nor shareholder equity. Overuse may make the investor feel that a company’s instability or perhaps even overvaluation is a sign that it is using splits to alter market sentiment instead of real growth indicators.

Reverse share splits can be quite damaging; they usually occur due to financial stress or a compelling necessity to attain minimum price requirements for an exchange listing, for example, on BSE or NSE. This would provide a negative impression in the minds of investors and, therefore, may lead to a decline in confidence.

Some investors may also view share splits as irrelevant to a company’s core performance metrics. Without strong fundamentals or positive news on growth prospects, a share split may not be able to sustain interest or momentum in trading activity.

Although stock splits can enhance liquidity and make stocks more accessible to retail investors, they should be used with caution as part of broader investment considerations.

Real-World Example of a Stock Split

A good example of a share split in India is when Infosys performed a 1-for-2 stock split. Prior to the event, Infosys’ share price had appreciated considerably because of its strong performance in the IT sector and investor confidence in its growth trajectory. Before the share split, Infosys shares were trading at around ₹1,200 each.

After the 1-for-2 share split, they received one extra share for every share an investor had, so a shareholder who initially owned a share worth ₹1,200 would be left owning two shares worth approximately ₹600 each. This reduction did not affect the investor’s total sum of holding at ₹1,200; it merely spread the equity over two individual shares as compared to earlier but at a retail-friendly share price.

This increased the liquidity and made Infosys more attractive to smaller investors who could have found the higher-priced stocks too expensive. With the share split, Infosys saw more trading volume and remained on an upward trend with its stock price as investors flocked in.

Frequently Asked Questions

What are the reasons for stock split

One of the most popular reasons for a stock split is to bring the stock in a more acceptable trading range for retail investors. For example, if a stock is quoting at Rs.5,500, then not to many retail investors. Instead, if the company does 10:1 stock split, the price will come down to Rs.550 and make it more reachable for retail investors.

What is reverse stock split

Reverse stock split is also called stock consolidation and is the opposite of stock split. In stock split, for example, you reduce the face value of the share from Rs.10 to Rs.5. In reverse stock split, you can take the par value from Rs.5 to Rs.10. Reverse stock splits are not as common as stock splits.

What happens if I own shares that undergo stock split?

You don’t have to do anything. If your shares were in your demat account on the record date of the split, then split shares with a new ISIN number will be automatically credited to your demat account.

Does the stock split make the company more or less valuable?

Stock splits are value neutral, in the sense that they neither increase value of the company nor reduce it. The only thing is that they bring stocks in a more acceptable trading range and improve demand.

Is a stock split a good thing?

It may be helpful in terms of liquidity and making the stock more accessible to the average retail investor, thus increasing the potential investor base. On the other hand, the company’s market capitalization or intrinsic value will not be affected by this kind of share split.

What is a 2 in 1 stock split?

A 2-for-1 share split is one where each existing share is split into two. If a person has 100 shares that cost ₹ 800 per share, for example, they will end up having 200 shares but now costing only ₹400 each. Total investment becomes the same, that is ₹80,000.

What does a 4-to-1 stock split mean?

The term 4-for-1 share split means that an existing share splits into four shares. The same investor holding 50 shares priced at ₹1,200 earlier now holds 200 shares priced at ₹300 each later on. The total investment remains the same at ₹60,000.

What is a 20 for 1 stock split?

A 20-for-1 share split is one in which if a given number of shares an investor owns is split, then he gets 20 times the count of shares. Thus, if an investor has 10 shares priced at ₹500 each earlier, he will have 200 shares priced at ₹25 each later. The total value of the investment remains the same.