What is Stock split – Economical impact on investors

Companies in India and abroad are looking for a wide shareholder base. If shareholder base is bigger then chances of getting companies ownership to small group of investors is less.

To have a wide investor base, companies attract individual investors to invest in their company. In that process, management keeps the stock price in between a sweet or attractive range which allows small investors to hold 100 to 200 numbers of shares. Gradually these average investors can accumulate by increasing their share holding.

Primary objective is to make shares more attractive and affordable to small investors in comparison to similar companies in their sector.

If share price of a particular company is not attractive to small investors then management may take decision of stock split to make it more attractive to investors.

Below in this article we will discuss what is stock split and how value of share is adjusted to make it more attractive to investors.

stock split or share split

 

What is stock split?

Stock split means dividing company’s current outstanding number shares into multiple numbers of shares and proportionately adjusting its share price to compensate investors.

Even though price and number changes, the rupee value of shares remain unchanged compare to pre-split amounts.

Say you own 1000 stocks of XYZ Company. Current market price of XYZ Company’s stock is Rs. 100 each. Management has decided to have stocks at the rate of 10 each instead of having Rs. 100. To do that management has to go for 10-for-1 stock split.

After the split, stock price will be reduced from Rs. 100 to Rs. 10 each and number of shares will be increased proportionately. In our case, you would own 10000 numbers (1000 * 10) of shares at a price of Rs. 10 each (100/10).

Net financial impact in the hands of shareholder will remain same i.e. in our case its Rs. 100000.

It’s not necessary that stock split should only be 10-for-1. The most common stock split are, 3-for-2, 2-for-1 or 3-for-1.

Pre stock Split Post stock Split
Stock Split Ratio 10 for 1
Number of shares 1000 10000
Market price 100 10
Value of shares 100000 100000
Stock Split Ratio 2 for 1
Number of shares 1000 2000
Market price 100 50
Value of shares 100000 100000
Stock Split Ratio 4 for 1
Number of shares 1000 4000
Market price 100 25
Value of shares 100000 100000

Possible reasons for stock split

You must be thinking why companies in India or abroad go through stock split process even though there is no impact in the hands of investor. Here is why.

First, some companies believe that by increasing number of shares in market, the value of shares will come down to a reasonable level which will make the stock inexpensive. As a result more investors can afford to buy company’s stock at a general lot size of 100 or 200.

Second, increase in number of stocks and inexpensive value will attract more investors to buy and sale share in market by which it will result in greater liquidity.

In India ITC, HDFC and Bharti Airtel shares were split in the ratio of 1:10 on 21st September 2005, 1:5 on august 17, 2010 and 1:2 on 24th July 2009 respectively.

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