All about stock splits

Stock splits refer to dividing the outstanding shares of a company into a larger number of shares, without affecting Stockholder's Equity or the total market value of the stock. For example, if a company declares a 2-for-1 stock split of its stock, of which has a current market value of Rs 500/share and 200,000 shares outstanding, the following results occur:

Pre-split:
Outstanding shares: 200,000
Market Value: Rs 500
Market capitalization: Rs 100,000,000

Post-split:
Outstanding shares: 400,000
Market Value: Rs 250
Market capitalization: Rs 100,000,000

Essentially, in the 2-for-1 stock split, the company's outstanding shares are simply doubled and the stock price is divided in half. The market capitalization, or market value of the stock, remains the same at pre- and post-split conditions. This is because stock splits have no impact on the value of a company's stock. A stock split is merely an accounting transaction in which no equity is exchanged. Companies can split their stock in any number of ways. These splits may occur in different combinations.

When a company declares a stock split, the price of the stock may decrease, but the number of shares will increase proportionately. A stock split has no effect on the value of what shareholders own. If the company pays a dividend, your dividends paid per share will also fall proportionately.

Companies often split their stock when they believe the price of their stock exceeds the amount smaller individual investors would be willing to pay for the stock. By reducing the price of the stock, companies try to make their stock more affordable to these investors.

Usually, stock splits have a positive affect on the stock price. Over the long term, stock splits seem to have a considerable effect on the company's stock price. Although stock splits have no direct effect on a company's equity, the event of a split does forecast hints and signs of how the company is performing.

Companies usually tend to split their shares when the company has an optimistic view of its future and operations. The announcement of a stock split can be a symbol that a stock has attained a certain level of success. The fact that a company has a record of multiple stock splits usually indicates that the company is among one of the faster growing firms, since their stock has been split numerous times. Generally, a company is motivated to split their stock to attract more investors with a lower share price.

However, some people can only buy lower priced stock because they may not have the buying power to make a larger investment. Thus, they wait till a stock splits so they can afford some shares. Just because a company declares a stock split, it does not mean that the stock price will inevitably rise in reaction. There are many other variables that influence investors' decisions in the result of a stock split including economic reports, market stability, earnings, interest rates, external conflicts, etc.

Companies also split their shares if they need to broaden their shareholder base and make more shares available to investors. A motivation for this could be a company's defence to a potential hostile takeover. Stock splits make the company more liquid, allowing more investors the opportunity to purchase an ownership in their company.

The timeline of a stock split consists of four main dates: Declaration or announcement date, Record date, Payment date, Ex-dividend date. The two key dates that are important to investors are the announcement date and the payment date. The announcement date is important because no one knows for sure if and when a company a will declare a split of their company's stock. Thus, investors speculate on whether the company will announce and when they will announce. The payment date is crucial as well because this is the day before the company actually splits its share price, after which investor activity changes as the new share price targets a different audience.

Moreover, there is another factor that engenders the announcement of a stock split. Companies tend to try to keep their stock within a certain price range. Therefore, when a stock hits the company's price target, the company, upon approval of the Board of Directors and the shareholders, will announce a stock split.

A stock split simply involves a company altering the number of its shares outstanding and proportionally adjusting the share price to compensate. This in no way affects the intrinsic value or past performance of your investment, if you happen to own shares that are splitting. With lower-priced shares, a stock's liquidity increases and making it easier to trade.

As a stock price rises, some people will be psychologically unwilling to pay that 'high price' so a stock split brings the shares down to a more 'attractive' level. Again, the intrinsic value has not changed, but the psychological effects may help the stock.

Via ET