Stock splits usually tend to draw a lot of attention in the stock market. Investors hold the perception that when a company declares a split, the value of the company increases automatically. However, a stock split mainly changes how a company’s shares are structured in the market.
Knowledge of stock splits is relevant to investors who want to analyse companies effectively. Splitting may change the price of shares and the available quantity of shares in the market. In this article, we discuss the concept of stock splits and whether it really changes the value of a company.
What is a stock split?
A stock split is a corporate action where a company increases the number of its outstanding shares. Meanwhile, the price of the individual share is decreased in an equal proportion such that the total investment value stays unchanged. It results in a change only in the share structure and not in the fundamentals of the company.
To illustrate, if a company declares a 2-for-1 split, each shareholder is given two shares for every one share held by them. Assuming that the share price was ₹1,000 prior to the split, it might become ₹500 following the split. While examining all stocks listed in the market, investors observe that many companies declare stock splits periodically.
Do stock splits change company value?
An upcoming stocks split does not result in changing the fundamental value of a company. It can be seen that the market capitalisation of the company stays unchanged before and after the split. Market capitalisation is determined by multiplying the total number of shares by the share price.
Once the split has been made, the share price goes down, but the number of shares goes up in the same proportion. The overall valuation of the company remains the same since both values change at the same rate. The revenue, profits, and assets of the company also stay the same.
Why do companies announce stock splits?
Stock splits are usually announced by companies when their share price rises substantially over a period of time. Small investors can be discouraged from purchasing the shares at a very high price. A reduction in the price per share helps companies to make their shares more accessible.
Liquidity in the market can also be enhanced by a lower share price. In the long term, a company’s shareholder base can increase with the help of a stock split, which can be advantageous for the stock’s performance.
Moreover, there is an improvement seen in trading activities when more investors can buy and sell the stock. For this reason, a number of investors monitor upcoming stock split announcements in the market.
How stock splits affect investors
When a company declares a stock split, then the existing shareholders are automatically given additional shares. Nevertheless, the overall value of their holdings is the same following the split. The splits do not alter the fundamental value of a company, but they can critically impact the market perception and investor behaviour.
From the viewpoint of an investor, a stock split can indicate that a company’s management is confident about the future as well as believes that the stock price will continue to rise. However, it is essential for investors to focus on more than just the nominal value and comprehend the strategic reasons behind a stock split.
Final thoughts
Summing up, stock splits have the potential of enhancing accessibility and trading activities in the market, without bearing on a company’s intrinsic value. A reduced share price can lure more investors and increase liquidity.
Investors need to understand that stock splits are mainly adjustments to the quantities and prices of shares. They need to concentrate on the fundamentals and financial health of the company and not just on the announcement of stock splits to make informed decisions.
