Stock split is generally done by companies that have seen their share price rising to levels that are either too high or beyond the price levels of similar companies in their sector. Some investors may consider stock splits as gifts. When a company splits a stock, there is very little proof that one may benefit in any significant way when a company splits a stock. Lot of investors believes that splits are a good idea but they might not be correct in all conditions. So let’s first understand what is stock split?
What is stock split?
Stock split is essentially when a company increases the number of shares. Say for example, you own 25 shares of a certain company at $15 a share and there was a 2-1 stock split. This means that you would own 50 shares worth $7.50 each. When a stock split occurs, it may also result in a stock price increase followed by a decrease immediately after the split. As the small investors think that the stock is now more affordable and buy the stock, they end up increasing the demand and raise the prices. There are stock splits such as 3-for-1, 3-for-2 but the most common one is 2-for-1.
Why does a company split a stock?
The companies split their shares when they think the price of their stock beats the amount smaller individual investors would be willing to pay for the stock. By cutting the price of the stock, companies try to make their stock more affordable to these investors. It is becoming a rage among the corporate to undergo stock splits. Stock splits are very common in the U.S. They also serve the purpose of raising liquidity without increasing the company’s equity servicing burden. Stock splits also increase the affordability of a stock and also permit greater participation from the retail investors. Some companies split their stock fairly frequently and for others it’s a rare event. The reason for companies opting for stock split is dependent on how rapidly the stock price is rising. One of the leading American business magnate, investor and philanthropist Warren Buffet’s company Berkshire Hathaway has never split his stock. Some of the Indian companies undergoing stock split include Zee, Reliance Industries, Infosys and Satyam. The stock splits generate an excitement in the market and also result in price appreciation.
Are stock splits good for investors?
Many investors feel that a stock split is a symbol that stock is doing well and is considered as a sign for buying stock. There are many arguments over whether a stock split is an advantage or disadvantage to the investors. Some investors say that a stock split is an indication that the stock is doing well and it is considered as a green signal to buy the stock. The announcement of a stock split attracts attention to the success of a company which also results in higher prices and increased buying. The companies will also report high earnings and increase dividends at the same time they declare stock split. The reduced price per share after the companies split the stock also attracts many small investors. As many information services and news report stock splits, the announcements themselves have become a market-moving force.
Advantages of stock split
Affordability of each share is improved: Each share of the stock has half the value it did before. Someone who would not buy a stock share that costs $250,000 may buy a stock share that costs $125,000. Thus, the universe of potential buyers of a share of stock may increase if the price of each share is lowered through a stock split.
Some investors prefer stocks that keep splitting: Since very successful companies split their stock every few years, during their rapid growth phase, there is aura of vitality around a company that needs to keep splitting its stock to keep it in the $5 to $200 range per share.
Splitting stock yourself helps you shun having other people split your stock for you: If a company chooses not to split the stock, other people can create a business whereby they sell shares of their entity that own shares of the stock that won’t split.
Thus, stock splits have been used by companies to increase or lower the number of outstanding shares. They are an interesting feature of investing and good piece of knowledge for those who are learning about the stock market.