What Happens When Stocks Split
Stock splitting is one of the best things that can happen to an investor. When a stock splits, then the stockholders would receive twice as many shares as before. Though the volume of the shares would almost double, the value of each share would be reduced. Supposing a company splits its stock two-for-one, i.e. it issues one new share on each existing one, then the value of each share would be reduced to half. Thus the number of shares would become twice as before, but the total value would remain unchanged. It's something like getting two five-dollar bills in place of a single ten-dollar bill. The value would remain the same, but the bulk of paper would become twofold.
Sometimes an investor may feel a stock to be quite beyond his/her reach due to the high price per share of the stock. But when the stock splits, then the reduced value becomes much more affordable to the smaller investors. A $100 share could seem to be too much to invest in, but if it is split two-way, then the $50 stock would seem to be more affordable. This is the reason why companies go ahead and split their stocks. It plays favorably on the psychologies of their investors and they build on more capital.
There are a number of ways in which companies split their stocks. The most common ones are two-for-one, three-for-two and three-for-one. There can also be a reverse splitting of the stocks; i.e. reducing the number of outstanding shares so that each company has fewer shares than before. Such reverse splitting is very uncommon, but it may be used if the company feels that the price per share is so low that it reflects as a bad investment to their investors. A very low share value could also entail delisting from the stock exchange, or it may simply be a way of the company to go private.
Due to the lower prices, the companies build up more liquidity by splitting their stocks. Lower prices mean more possibility of selling the stocks since the investors could place them better within their budgets to buy them. However, high share prices could be intimidating to the investors.
One more advantage of stock splitting is that it is perceived as an indicator of a bullish market. If the stock prices are increasing, it might mean that the company is doing well financially. The rally around the stock could last for a short time after the splitting, but generally it pulls itself back to normal quite fast.
But a stock splitting could also cause the investors to raise their hopes about the company's potentials. Therefore the company would need to live up to the standards the investors have come to expect, or they risk losing investor confidence.
In conclusion, we can say that a stock split does nothing to improve or worsen the performance of the company. It may look like a great deal of shares considering sheer bulk, but there is no change to the face value of it all.
by Tom Johanson