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Stock Split – Its Types, Benefits, and Disadvantages

Listing companies engage in corporate activities, such as distributing dividends and issuing bonus shares. So, anytime a corporation declares a stock split, its issued share increases. However, it doesn’t impact the market capital. No matter how often it’s split, the fundamental value remains constant. It also implies that with a rise in the number of existing shares split, the price of every share will also increase.

Stock Split – Its Types, Benefits, and Disadvantages
Overall, it’s a good sign for prospective and current investors.

Stock split – What it is
Typically, a stock split refers to a situation wherein a listed company undertakes a corporate action. It implies that it divides every current share it owns into multiple newer shares without changing its overall value. Since the fundamental value per share remains the same, the stake of every investor also stays constant. However, with this corporate action, the company’s total share increases.

Stock split – How it works
Obtaining stock split information reveals that the situation does not affect anything beyond making the company’s shares more accessible to investors. So, the company fixes a ratio to decide the number of surplus shares generated by dividing the current shares. Investors will receive an equal proportion of the shares to their present holding in the company. However, the shares would be adjusted to accommodate the stock split.

Generally, the ratios companies employ are denoted as 3:1 or 2:1. So every share an investor owns before the split will be divided into three or two shares following the split.

Stock split – Its types
Broadly, a company can have two stock splits to cater to the share prices. Here are the  two stock split types:

1. Regular stock split
Under this situation, the company will do two things to accommodate stock splits and make the shares accessible to small investors:

  • It will expand the outstanding shares by issuing extra shares to the current shareholders.
  • The company will increase the number of shares, resulting in a natural price drop.

Overall, the company’s market capitalization and valuation remain the same, even with the increase in the shares and the decline in the price.

2. Reverse stock split
Under this situation, the company will reduce the number of remaining shares. It implies that one would end up with five shares if they had ten shares of the  company’s  stock and the board announced a 2-for-1 split. Again, it does not hamper the value of the shares.  Here’s  an example:

Suppose one had ten shares worth $4 each b efore  the reverse stock split. After the split, one would have five shares, each worth $8. So, in both situations, one holding would be worth $40. However, one would now have fewer shares than before.

Stock split – Its benefits
Now that one has a preliminary understanding of stock split info, here are some of its advantages for the shareholders:

  • Shares are more accessible
    Often, companies decide to split stock because of its high share price. When a share price rises sharply, investor demand may be dampened. However, a company can reduce its share price through share splits, making it more accessible to investors without impacting its overall value.
  • It increases liquidity
    Another of the top stock split benefits is a rise in liquidity. Following a split, the shares become more accessible to retail investors, and their demand increases. The increased demand also spikes liquidity as buying and selling become easier after a split.
  • It simplifies portfolio rebalancing
    When the price per share falls, it is easier for the managers to sell the shares and buy new ones, as every trade is now a small chunk of the portfolio.
  • It increases the share price
    If one goes through the list of stock-split companies, one will notice that the general trend is that the split often results in a price rise. Though this effect dies over time, many blue-chip companies did see a bullish trend following the stock split.

Stock split – Its disadvantages
Not all stock split facets benefit the company. This process is usually expensive. Further, it demands legal oversight and ought to be performed following regulatory laws. Moreover, companies hoping to be included in the list of stock-split companies must spend heavily to ensure no movement in capitalization value. While the stock split is not worthless, it won’t impact the company’s fundamental position. Hence, a stock split does not create value.

Further, a stock split may trigger volatility, and the investors may want to invest in the stock if it is cheaper. It might amplify volatility. The stock split may not necessarily increase the price, as some splits happen when the stock is about to be delisted. It is called the reverse stock split.

As with other operations of the corporation, such as bonus shares, the stock split is also credited automatically to the Demat account within four to five days from the record date stated by the company. One can check the account statement to ensure the split shares are credited properly. The bottom line is that a stock split won’t change the company’s fundamentals, and that’s where the analogy ends. Regardless, it generally induces more demand, either through demand from fund managers, increased accessibility, or the signaling effect. So, even though it is typically bullish, the company’s performance over time determines the future value of every share.

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