Share split – Calculation, benefits, example (2024)

Share split – Calculation, benefits, example (1)

Every stock market investor wants thatinvest in sharesthat can yield a good return. Often, shares of a sought-after company are not available for many investors to invest in. One of the most common reasons is the high share price. During such periods, companies may decide to split their shares, resulting in a stock split.

What is a stock split?

A stock split is:

when a company's board issues more shares
issued to current shareholders
when the current value of a shareholder's share is not diluted

It essentially lightens the total number of shares outstanding for a company and reduces the value of each share. So even though the total number of shares outstanding increases, the company's valuation and the value of a shareholder's share of the company do not change.

Here is an example to understand this:

Suppose you own a share of the stock of ABC company. If the company announces a 2-for-1 stock split, you will be awarded an additional share. However, each share is now valued at half its original value. After the split, the two shares you own are worth the same as the share you previously owned.

Stock investments made easy @ Fisdom!

How is the stock split calculated?

Shareholders who want to estimate the total number of shares they will own after a stock split can use the following formula:

Total number of shares after stock split = number of shares * number of new shares issued for each existing share.

Calculation of the share price after share split

If you want to knowof the priceafter a stock split, the following formula can be used:

New Stock Price = Old Stock Price/Stock Split Ratio

So if a stock you own last traded at a price of Rs.100 and the company has announced a 3:1 stock split, the new price of the stock will be:

= 100 /(3:1)

= 33,33

Why do companies announce their stock splits?

Here are some common reasons for this:

Higher liquidity

One of the main reasons why companies announce stock splits is to achieve higher liquidity. In many cases, the company's stock price may be too high for investors to easily purchase. Any further price increase could further deter investors from participating in the company's stock ownership. By lowering the value of a stock through a stock split, the shares can be made available to a larger investor population, resulting in higher liquidity.

Broader shareholder base

Through this corporate action, a company can increase the number of outstanding shares and offer a broader investor base the opportunity to purchase its shares. This helps the company increase its shareholder base.

Future growth perception

Companies that announce stock splits are generally considered to be in the growth phase. Such announcements are seen by investors as an indication of the company's intention to achieve growth. This helps in creating a positive market image about the company.

Disadvantages of a stock split

Some disadvantages of stock splits are:

Reduced liquidity: Stock splits can increase the number of shares outstanding, potentially reducing liquidity and making it more difficult to buy or sell shares.
Lower price per share: The lower share price after a stock split can attract more retail investors, leading to greater volatility and potential market manipulation.
Market perception: Some investors view stock splits as a signal of overvaluation, which can affect the stock's perceived value and future performance.
Transaction costs: Investors may incur additional transaction costs, such as brokerage fees, when they buy or sell a larger number of shares.
Psychological impact: Stock splits may cause short-term excitement, but they do not fundamentally change a company's value, and investors should focus on the underlying fundamentals rather than just the split.

The table below highlights the key differences between these two:

	Stock split	The bonus share
Meaning	Existing outstanding shares are split into multiple shares.	Additional shares are provided to shareholders free of charge.
Nominal value	Reduces in the same proportion as splitting.	Doesn't change
Why used by companies	To increase liquidity in shares. Lower the stock price and let more shareholders participate.	Used as an alternative to dividends. For the distribution of accumulated reserves
Example	If a 1:2 stock split is announced, the investor will have a total of 2 shares for each share.	If a capital issue is announced at a ratio of 3:1, shareholders will receive 3 shares for free for each share held. Example – for 10 shares you own, you get a total of 30 (3*10) shares.

Conclusion

Stock splits can provide companies with higher returns. It is seen as an indication of the good performance of a stock and therefore helps with a price increase in the future. According to historical evidence, many stocks that have gone through a split are known to become profitable for investors in the long run.

Frequently Asked Questions

What is a reverse stock split?

In a reverse stock split, a company reduces the total number of shares outstanding by a certain percentage while increasing the stock price by the same percentage. For example, if someone has 10 shares of Rs. 200 each and the company announced a 1:2 reverse stock split, the number of shares held will now total 5 worth Rs. 400 for each.

How does a company decide on a stock split?

The ratio of stock splits depends on the decision of the company and its objectives.

What are the advantages of a reverse stock split?

Reverse stock splits help a company recover from losses and can avoid a negative outcome such as delisting. Many stocks typically show an upward price trend following reverse stock split announcements.

How can investors benefit from stock splits?

Investors can benefit from stock splits depending on whether they currently invest in the company. They can also explore the possibility of a stock split announcement and invest in stocks to take advantage of the higher liquidity.

What is the difference between a stock split and stock dividend?

A stock split increases the number of shares outstanding in a company, while a stock dividend is a predetermined number of shares paid out to existing shareholders in lieu of a cash dividend. Both increase the number of shares outstanding and therefore a proportionate reduction in share prices.