What is a Stock Split?
When you hear the term stock split, it may sound complex at first, but it’s actually a common corporate action that can have an impact on your investments in the stock market. In this blog, we will explain what a stock split is, how it works, and its implications for you as an investor in the Indian stock market.
What is a Stock Split?
A stock split occurs when a company increases the number of its outstanding shares by issuing more shares to existing shareholders. This is done in proportion to the shares they already own, while the overall value of the company remains unchanged.
For example, in a 2-for-1 stock split, shareholders will receive one additional share for every share they currently hold. If you own 100 shares of a company, you will now own 200 shares after the split, but the total value of your investment will remain the same, assuming the stock price adjusts accordingly.
How Does a Stock Split Work?
Let’s break it down with a simple example:
-) Suppose Reliance Industries Ltd. announces a 2-for-1 stock split.
-) If you hold 100 shares of Reliance Industries priced at ₹2,000 per share before the split, your total investment value would be ₹200,000 (100 shares × ₹2,000 per share).
-) After the stock split, you will have 200 shares, but the price per share will adjust to ₹1,000 (₹2,000 ÷ 2). Your total investment value remains the same at ₹200,000 (200 shares × ₹1,000 per share).
The stock split does not affect the overall value of your investment, but it increases the number of shares you own and reduces the price per share.
Types of Stock Splits
There are different types of stock splits, which vary depending on how many additional shares the company issues:
1 ). 2-for-1 Stock Split: This is the most common type, where shareholders receive two shares for every one share they own. For example, if you hold 100 shares, you’ll now have 200 shares.
2 ). 3-for-2 Stock Split: In this case, shareholders receive three shares for every two shares they own. If you own 100 shares, you’ll now own 150 shares.
3 ). 5-for-1 Stock Split: Shareholders receive five shares for every one share they own. If you own 100 shares, you will now have 500 shares.
Why Do Companies Undertake a Stock Split?
A stock split is typically undertaken by companies when their stock price has become too high, making it less affordable for retail investors. The goal is to make the stock more accessible to a wider pool of investors and increase trading liquidity.
Here are some reasons why a company might decide to conduct a stock split:
1. Increase Liquidity: By lowering the stock price, the company may attract more buyers and sellers, which increases the liquidity of the stock.
2. Make Shares More Affordable: A high stock price may deter small investors from purchasing shares. By splitting the stock, the company makes it more affordable for retail investors.
3. Positive Signal: A stock split can be seen as a signal of confidence from the company. It often happens when the company’s stock price has been rising consistently, indicating strong performance and future prospects.
For example, Tata Consultancy Services (TCS) may announce a 5-for-1 stock split if its stock price is rising significantly and they wish to make the shares more affordable to retail investors.
Impact of a Stock Split on Shareholders
1. No Change in Total Investment: The total value of your investment does not change after a stock split. The only change is the number of shares you own and the price per share.
2. Potential for Lower Share Price: A stock split results in a lower price per share, which may make the stock appear more affordable to investors. This could attract more buyers, potentially increasing the stock’s demand.
3. Psychological Effect: A lower share price can create a psychological effect where investors perceive the stock as more affordable, even though the value of the investment remains the same.
Stock Split Example in the Indian Stock Market
Let’s look at a real-life example from the Indian stock market. Suppose Infosys Ltd. announces a 3-for-1 stock split:
1. You currently own 100 shares of Infosys, priced at ₹1,500 per share.
2. After the stock split, you will now own 300 shares of Infosys, but the price per share will adjust to ₹500 (₹1,500 ÷ 3).
3. Your total investment value will remain the same at ₹150,000 (300 shares × ₹500 per share).
Although the number of shares you own has increased, the overall value of your investment remains unaffected. However, the lower share price might make the stock more attractive to smaller investors.
Stock Split vs. Bonus Issue
It’s important to understand the difference between a stock split and a bonus issue:
1. Stock Split: The company issues additional shares to shareholders by splitting the existing shares. The overall value of the investment remains the same, but the number of shares increases, and the price per share decreases.
2. Bonus Issue: In a bonus issue, a company issues additional shares to its shareholders without changing the share price. The company may issue bonus shares based on the number of shares you already own. For example, a 1:1 bonus issue would mean you get one additional share for every share you already hold
Key Points to Remember About Stock Split:
1. No Impact on Investment Value: The total value of your investment does not change after a stock split. Increase in Shares,
2. Decrease in Price: The number of shares you own increases, but the price per share decreases.
3. Increased Liquidity: A stock split can improve liquidity by making shares more affordable and accessible to a larger number of investors.
4. Company’s Confidence: A stock split can signal that the company is performing well and is confident about its future growth
Conclusion
A stock split is a useful tool for companies that want to make their shares more affordable and increase liquidity in the market. For investors, understanding how stock splits work can help you make informed decisions about buying or selling shares. In the Indian stock market, stock splits are common among high-performing companies like TCS, Infosys, and HDFC Bank, and can be a sign of growth and future prospects.
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Disclaimer: The information in this blog is for educational purposes only. Please consult a financial advisor before making any investment decisions.