When you are an investor, stocks splitting can be a good thing. A stock split is a tactic for making the stocks more attainable to smaller investors and companies with sky-high prices are no exception.
What Is A Stock Split?
Stock splits are often confused with IPOs. While IPOS and stock splits are both used by companies to stimulate new business, they serve very different purposes. When a company issues an IPO, it first sells its shares as currency to the investors at a fixed price then converted into equity.
In contrast, when a stock split is issued, the new shares are issued at the same price as the old ones.
When companies choose to do this strategy it means their shares will become cheaper when trading which attracts new buyers who wouldn't have been able to afford them before, just because they were too expensive in comparison already.
But now that there's only half the amount of price per share people don't feel as bad if they buy one or two instead of twenty at once, so then startups get money from all over while some old billionaires still keep being rich.
While stock splits tend to be substantially less expensive for a company to initiate, they have only limited benefit for shareholders and investors.
A stock split is usually an effort by companies to make their stocks more appealing to potential investors who will pay attention to the "penny" stocks and "micro-caps". These companies may not have a minimum value of up to $1 per share, but still attract investors who are willing to buy stocks even at a small unit price. The spread between the bid and ask prices can be as high as 3% in the case of low-priced stocks.
A stock split means that each shareholder will own the same number of shares, but each share will correspond to a smaller percentage of ownership in the company.
For example, if XYZ Corp., with 300 outstanding shares trading at $50 per share splits 2-for-1, then shareholders will have 150 shares worth $33.33 each ($50 x 150/300). A 3-for-1 split increases the number of shares held; in this example, it would be 450 shares ($50 x 150/300 x 3).
What Are The Advantages Of A Stock Split?
i- A stock that has been recently issued but is very unpopular, for example, may have to offer a free gift or a giveaway to get investors. A collection of small stocks could also benefit from a stock split, as they could attract the attention of large investors.
ii- A company's stock is sometimes split in preparation for an IPO. An IPO can be a way to raise funds for companies that are unable or unwilling to issue debt. A lower initial share price can encourage more people to invest in a company and increase the available pool of investment capital.
iii- Stock splits can also be used to keep a stock's price from falling below a certain level. In some exchanges, stocks with low current prices are subject to delisting because they do not meet minimum maintenance standards for listing.
What Are The Disadvantages Of A Stock Split?
i- The disadvantages of stock splits include confusion among investors and the new shareholders' inability to make an accurate appraisal of the company's performance. Stock splits do not usually affect a company's fundamentals, but they can lure investors into thinking that the shares are trading at a lower price per unit and can be more attractive to potential buyers with small budgets.
ii- Stock splits also introduce complications for companies with multiple share classes (such as employee stock options) or convertible securities. The number of outstanding shares could increase significantly, causing shareholders' equity to be reduced by dilution and impacting many calculations based on the number of shares outstanding.
iii- Furthermore, a stock split may lower the value of an existing dividend or interest rate because they are usually calculated on a par-value basis. It is also possible for investors to engage in short selling following a split, as they can borrow stock and sell it, betting on the fact that the shares will be worth less when re-purchased later.
What Happens When A Stock Splits?
i- The ownership of a company's outstanding shares is equally divided among shareholders.
ii- The number of outstanding shares decreases as a result, and the price per share increases.
iii- Many small changes in the prices of individual stocks add up to significant changes in the stock market as a whole.
iv- Stockholders do not have any direct impact on the price of a stock.
What Types Of Companies Perform A Stock Split?
i- High-performing growth companies
ii- Companies with a low stock price
iii- Corporations that are trying to get their stocks onto major exchanges or avoid delisting from an exchange.
How To Take Advantage Of A Stock Split?
It is always important to do your own research and not blindly follow the advice of some guru. Stock split can be a good news or bad news depending on how you look at it. From my research, there are 2 ways of looking at this event:
i- It's a neutral event - In most cases stock split will leave stock price unchanged, hence it has no impact on the value of your portfolio.
ii- It's an un-expected gift - A stock split is like a present that keeps on giving. Not only does it reward me with more shares when I own just one, but also those extra shares are often not grouped together. There can be cases where some of my shares are grouped, but a majority is not. Therefore, every time the merger proposal comes up, I have to do some housekeeping and vote AGAINST it. By doing that I can sever ties with bad portfolio company and let those undesired shares go out into oblivion while keeping the real gold in my portfolio intact.
iii- Although stock split is mainly a cosmetic change to your portfolio, it is always a good idea to look at the long term. If you have owned stock for more than 5 years and stock price has increased by 4X or more after the split, then it's a great time to sell off your shares. Why? Because share of high performers like these will be very rich for the market cap.
How Does A Stock Split Affect You As An Investor?
To answer this question, you have to know what ratio your stock has been trading in. For example, if the current price is $40, and after the split it becomes $10 per share, then the new ratio will be 1:4.
That means for every share that you have prior to the split you will now own four shares at same price. The main advantage of this is that you are not buying additional shares but rather getting more for your money, i.e. for the same amount of investment you now own four times as many shares as before the split.
This way you can increase your investment without actually spending any extra cash in order to do so (in theory anyway).
How Does A Stock Split Affect The Company's Value?
The company is not affected in any way. A lot of people believe that when a stock splits, its price goes up. Although it may temporarily go up, it will eventually drop back down to the original stock price. For example, if you have 1 share worth $100 and the company splits, the stock price by 2 and makes it worth $50 then after some time it will go up to $75 and then go back down. Hence, there is no difference in value for the companies themselves.
When a company issues more stock in an attempt to boost its share price, new shareholders may end up owning a smaller percentage of the company's outstanding shares than they had before—a situation that might give little incentive to own the stock in the first place. New shares often trade at a discount for some time after a split is announced, as investors might not see the point of owning something that represents a smaller stake in the company than before.
Stock splits are more common among businesses with smaller market capitalizations and companies that are valued at less than $1 billion.
The vast majority of companies that perform stock splits have a market capitalization of $100 million or less, according to New York University's Stern School of Business. Yet a small percentage of the Fortune 500 has split their shares within the past five years—the most popular reason is to ensure inclusion on major U.S. exchanges and avoid delisting.
Conclusion
You will have got a plenty of information regarding what is a stock split and how it affects your stock portfolio. Share your thoughts with us in the comments section and do share further information related to stock splits.
