What Is A Stock Split?

March 09, 2023

Introduction

A stock split is a corporate action in which a company divides its existing shares into multiple shares to boost the liquidity of the shares. It is typically done when a company's stock price has risen to levels that may be too high for some investors to buy. By splitting the stock, the price per share is reduced, making it more affordable for investors. For example, if a company with one million shares outstanding splits its stock 2-for-1, it will then have two million shares outstanding and each share will be worth half as much as before.

The primary purpose of a stock split is to make the stock more accessible and attractive to potential investors. By reducing the price per share, more people can afford to buy it and this can lead to increased demand for the stock. Additionally, some investors may view stocks that have undergone splits as being undervalued and therefore may be more likely to invest in them.

How Does a Stock Split Work?

When a company decides to split its stock, it will announce the split ratio which indicates how many new shares will be issued for each existing share held by shareholders. For example, if a company announces a 2-for-1 split ratio, then each shareholder will receive two new shares for every one share they own. The total number of outstanding shares increases but the value of each individual share decreases proportionally.

After announcing the split ratio, the company will set an effective date on which shareholders must own their shares in order to receive additional ones from the split. On this date, shareholders are credited with additional shares based on their holdings at that time and these new shares are distributed accordingly. After this date has passed, all trades made on or after that date will reflect the new lower price per share resulting from the split.

Benefits of Stock Splits

Stock splits can provide several benefits for both companies and investors alike:

For companies: • Stock splits can help increase liquidity by making stocks more affordable and attractive to potential investors; • They can also help reduce volatility by decreasing large swings in prices; • They can also help increase market capitalization by increasing total number of outstanding shares;

For Investors: • Stock splits make stocks more affordable so they are accessible even with smaller investments; • They can also increase demand for stocks due to their lower prices;

Risks Associated With Stock Splits

Although there are many benefits associated with stock splits, there are also some risks that should be considered before investing in them:

• The reduced price per share may not necessarily result in increased demand or higher prices; • The increased number of outstanding shares could dilute earnings per share (EPS) which could lead to lower returns;

Additionally, some investors may view stocks that have undergone splits as being overvalued and therefore may be less likely to invest in them. Therefore it is important for investors to do their research before investing in any stocks that have undergone splits so they understand all associated risks before making any decisions.

Conclusion

In conclusion, stock splits can provide several benefits for both companies and investors alike but there are also some risks associated with them that should be considered before investing in them. It is important for investors to do their research before investing in any stocks that have undergone splits so they understand all associated risks before making any decisions.