What is a Stock Split and Why Do Companies Do It?
Every publicly listed company has a fixed number of outstanding shares. A stock split is a decision made by the board of directors of a firm to increase the number of shares outstanding by issuing more shares to present shareholders.
In a 2-for-1 stock split, for example, a shareholder receives an additional share for each share held. As a result, if a firm had 10 million shares outstanding prior to the split, it will now have 20 million shares outstanding following a 2-for-1 split.
Every publicly listed company has a fixed number of shares. A stock split can also affect the price of a stock. The stock price will fall following the split (because the number of shares outstanding has increased). The share price will be half in the case of a 2-for-1 split. As a result, while a stock split increases the number of outstanding shares while decreasing the share price accordingly, the company’s market capitalization remains unchanged.
Key Points:
- A stock split is a corporate operation in which a corporation raises the number of outstanding shares by issuing more shares to existing shareholders.
- Shares splits can increase trading liquidity while also making the stock appear more inexpensive.
- A stock split increases the number of outstanding shares while decreasing the price per share proportionally, although the company’s market capitalization and value remain unchanged.
- The most typical split ratios are 2-for-1 and 3-for-1, which mean that for every share held prior to the split, an owner will receive two or three shares.
- Reverse stock splits occur when a firm reduces the number of outstanding shares, increasing the market price of each share.
Why Do Companies Perform Stock Splits?
When a company’s share price rises to a nominal level that may make some investors uncomfortable, or when it exceeds the share prices of similar firms in the same sector, the board of directors may opt to split the stock. Even though the underlying value of the company has not changed, a stock split might make the shares appear more reasonable. It can also improve the liquidity of the stock.
When a stock divides, it might result in a gain in share price—even if there is a drop shortly after the stock split. This is due to the fact that small investors may perceive the stock as more affordable and purchase it. This essentially increases stock demand and raises pricing. Another explanation for the price increase could be that a stock split signals to the market that the company’s share price has been increasing; people may think that this growth will continue in the future. This increases demand and costs even more.
For Example:
Five Star Business Finance was trading around 6200 in the Pre-IPO space when the stock split of 1:10 was announced. Post the split, the price relegated to 620. As generally noted because of the split, the liquidity went up.
Oravel stays (OYO Rooms) DRHP states there were 2 bonus issues and a split.
2nd sept: bonus of 25 shares for every 160 shares
10 sept: split from FV 10 to 1
11 Sept: Bonus 3,999 shares for every share held
So ~46,238 shares for every share held earlier.
Such moves by companies to reduce per share value before going public while completely legal isn’t fully understood by retail investors. These massively inflate overall capital so the pricing (not valuation)seems digestable.
Guidelines and regulations might need to catch up in this region.
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