Stock Split Meaning, Benefits, Examples & Reverse Stock Split.

“Itna costly ho gai ho, abhi tak stock split nahi hau?” This modified dialogue from Gangs of Wasseypur was used for a meme to depict the angst and frustration of investors as the stock price of MRF kept rising and the stock just did not split. 

MRF currently trades at Rs 81,032. A normal investor just cannot buy MRF and those who own it won’t sell it so easily. Hence everyone is waiting for the MRF stock to split. And MRF won’t budge, leaving the investors miffed. 

But what is a stock split? When does it happen and how does it happen? Let’s know more about it so that next time when you see the meme, you know what it is talking about.

Content:

• What is a Stock Split?
• Stock Split Benefits
• Stock Split Example
• Reverse Stock Split
• Stock Split Companies
• Quick Summary

What is a Stock Split?

The effect of stock split on share price is important to understand. Stock split divides the existing shares into more shares. A company can split its stock into more shares for several reasons and in several ways.

One important detail to note is that when a stock is split, an increased number of shares are offered to the existing shareholders. Therefore, if an investor has 10 shares of X company and the stock is split 2:1, then this investor will have 20 shares of company X after the split.

So with the basic definition out of the way, let’s dig deeper. As told earlier, stock can be split in several ways — 2:1, 3:1, etc.

Now let’s get a few things clear. No matter what formula a company chooses to split the stock, the market capitalization of the company doesn’t change. However, the stock price reduces. A simple analogy: A whole pizza can be sliced into a lot of smaller portions to feed more people, but overall weight and size don’t change despite the slicing.

A stock split has a direct impact on the stock price. The more the company splits the stock, the cheaper the stock gets. 

Let’s say a stock worth Rs 1,000 split 2:1 will cost Rs 500. This will also mean that the earnings per share will also halve, but your overall portfolio earnings will still remain the same despite the split.

Why don’t you learn about the valuation of shares? 

Stock Split Benefits 

Now, there are several benefits of doing this for the company and for the investors as well. Check them out below:

• It increases liquidity: Cheaper shares attract more buyers, hence liquidity increases for the said stock.
• Since a very costly stock is out of bounds for regular investors, the shareholder base is small. With a split, the shareholder base increases.
• Investors can sell a few shares and keep some. Had there been no split, they would have either stayed with the stock or had to say goodbye to it.
• The stock generally becomes more profitable and investors earn good returns.

Stock Split Examples

Basic and most common stock split example is the 1:2 stock split (Also known as the 2 for 1 stock split). If it is a 1:2 stock split, then multiply your currently held shares by 2 and that is how many shares you will have after the split. Several companies try bigger splits. Tesla did it last year. It went for 1:4 split. It depends on how pricy the stock is and how much liquidity the company is seeking.

In February earlier this year, Finolex board announced a stock split in the ratio 1:5. It meant that one share of Rs 10 would be split into five shares of face value Rs 2 each.

Alkyl Amines Chemicals Ltd got the shareholders’ approval for the split of the face value of equity shares from Rs 5 to Rs 2. The stock soared after the announcement, fulfilling the agenda behind it.

Similarly, Vaibhav Global hit an all-time high of Rs 1,037 in May after the stock split. The split was done in the ratio of 1:5.

Foreign companies follow the same method of splitting the stock. Apple has split its stock 7 times since it got listed on the exchange in the US.

But here is a thing. While most stock splits carry the same rationale of increasing liquidity and making money for the investors, some pricy stocks such as Page Industries, MRF, Bosch, and even Berkshire Hathaway have never split stock even once. And there would be no investor in these companies who would say they are not happy with their investment. These companies are already making good returns for the investors.

Reverse Stock Split

It is exactly what you are thinking. A reverse stock split is the one where a company consolidates its shares into fewer shares, making the stock dearer. Like a stock split, this too doesn’t impact the valuation of the company. 

So, if an investor owns 100 shares of a company and the company announces a 10-for-1 reverse stock split, then this investor will be left with only 10 shares. While each share may have cost him Rs 10 when he bought 100, they will now cost Rs 100 each. This is generally done by the companies to avoid getting delisted from bigger stock exchanges.

Stock Split Companies in 2021

Several Indian companies have split their stocks in the year 2021:

We hope that you are clear about the topic. But there is more to learn and explore when it comes to the stock market, and hence we bring you the important topics and areas that you should know:

Quick Summary

Stock split is something that the company controls. Unless the investor really tracks the news about the company to the letter and can read between the lines, it is difficult to foresee such an event. However, it is not harmful to the investors. 

If anything, it makes trading more interesting. Just that not all splits generate good returns. Hence, it is important to keep track of the fundamentals of the company.