Stock Split: What It Is & How It Works

Stock Split_ What It Is And How It Works

A stock split occurs when a company’s board decides to divide its stock, which increases the number of outstanding shares. A single share of stock will represent a smaller portion of the company than it did initially. After the split, each share will own a lower market value.

What Is a Stock Split?

In simple words, it is exactly what it says: splitting the stock. They divide or split one share into multiple shares. When stocks are split, the number of shares increases and the individual value of each share decreases. However, the number of shares outstanding changes, while the overall valuation of the company and the value of each shareholder’s stake do not change.

Imagine you have a bar of chocolate. You broke down your big chocolate bar into ten bite-size pieces. In that case, you still have the same amount of chocolate, just in small pieces.

For example, you are the owner of one share of a company’s stock. If a company board announces a 2-for-1 split ratio, the company will give you an additional share. However, each share will have at half the amount of the original. After the split, your two shares will be worth the same as the one share you started with.

Why Do Stocks Split?

Why do companies opt for stock splits? Increasing the overall liquidity is the main motive behind the stock splits. A former investment counsellor, Amanda Holden, says, “You might not be able to buy Apple at $500, but you could buy it at $125”.

Liquidity refers to the ease with which investors can purchase or sell shares on a stock exchange. The lower the dollar amount of each share, the lower number of shares that are needed by even the smallest investor to purchase or sell that stock.

In addition, some companies split the stocks to meet minimum requirements remain listed on an exchange.

Types of Stock Splits

While a 2:1 stock split ratio is the most common, any other ratio can be issued by the company’s board of directors. In some cases, shareholders can also give stock splits.

Examples of stock splits:

  • 2-for-1
  • 3-for-1
  • 3-for-2
  • 4-for-1
  • 7-for-1

For instance, in a 3-for-2 stock split, the company approves three new shares for every two shares you have. You can find the total of your new share by multiplying your old share by 3, 2 or 1.5.

Is A Stock Split Good Or Bad?

Although a stock split does not immediately affect a company’s valuation, investors generally react positively to the news of a stock split. Stock split announcements usually indicate that a company’s board of directors is confident and attempting to appeal to investors by lowering the share price. The stock’s value will often grow if the stock split is adequate and the company can attract a new wave of investment.

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