Stock Split: Definition and Impact

Stock split is a process in which a company divides existing shares into several new shares to reduce the share price per unit without changing the total value of the investment. For example, in a 2:1 stock split, each share is split into two, so the number of shares owned by investors increases but the price per share is reduced by half.

Purpose of Stock Split

Increases Liquidity: Lowering the share price per unit makes it more affordable and can increase trading volume. High liquidity is important because it allows shares to be traded more easily and with lower transaction costs.

Avoiding stock prices that are too high: Keeping stock prices within a range that is comfortable for investors. Overpriced stocks may be difficult for individual investors, especially those with limited capital, to access. By carrying out a stock split, the company can attract more investors.

Reflects Optimism: Usually done after stock prices rise, indicating hopes of continued growth. Stock splits are often seen as a sign of a company's confidence in their future performance, which can provide a positive signal to the market and increase investor interest.

Impact for Investors

Investment Value Does Not Change: Stock split does not change the total investment value. For example, if you owned $1000 worth of shares before the stock split, you will own $1000 worth of shares after. Only the number of shares changes, while the total value remains the same.

Psychological Influence: Cheaper stocks are often perceived as more affordable, which can attract more buyers. Lower priced shares can create the illusion that they are cheaper, even though their fundamental value has not changed.

Effect of Dividends: If a company pays dividends, the dividend amount per share will decrease according to the split ratio. However, the total dividends received by investors usually remain the same. For example, if you received a dividend of $2 per share before a 2:1 split, after the split, you will receive a dividend of $1 per share, but with twice the number of shares.

Index Adjustments: In some cases, stock splits can affect stock index calculations. Price-based indices, such as the Dow Jones Industrial Average, may need to be adjusted to reflect changes in component stock prices.

Conclusion

Stock splits are a tool companies use to adjust share prices and increase liquidity without affecting the total value of the investment. By making shares more affordable, companies can attract more investors and create a more active market. Although a stock split does not change a company's fundamental value, its impact on liquidity and investor perception can provide long-term benefits for the company and its shareholders.