Why Do Companies Announce Stock Split?

A stock split is a corporate action where a company divides its existing shares into multiple new shares. While this doesn’t change the total value of the investment, it makes the stock more affordable and accessible to investors. But why do companies choose to announce a stock split? In this blog, we will explore the reasons behind stock splits and their impact on both the company and the shareholders, especially in the context of the Indian stock market.

What is a Stock Split?

Before understanding why companies announce a stock split, let's first briefly explain what it is. A stock split occurs when a company increases the number of its outstanding shares by issuing more shares to existing shareholders. The company does this in a fixed ratio, such as 2-for-1, 3-for-1, or 5-for-2, meaning shareholders receive additional shares based on the ratio.

For example, if Infosys announces a 2-for-1 stock split, a shareholder who owns 100 shares will receive 100 additional shares, resulting in a total of 200 shares. However, the price per share will adjust accordingly, so the total investment value remains unchanged.

Why Do Companies Announce a Stock Split?

Companies typically announce a stock split for several reasons, primarily to make their shares more accessible and liquid. Let's look at the most common reasons behind a stock split:

1. To Make Shares More Affordable

One of the most common reasons for a stock split is to make the company’s shares more affordable for retail investors.

-)In the Indian stock market, some companies like Tata Consultancy Services (TCS), HDFC Bank, or Reliance Industries may experience a significant increase in their share price over time. This can make the stock seem too expensive for smaller or retail investors to purchase.

-) A stock split lowers the price per share, making the stock more attractive to a broader pool of investors.

For example, if TCS's share price rises to ₹10,000, a retail investor may find it difficult to buy even a single share. After a 2-for-1 stock split, the price per share might reduce to ₹5,000, making it more affordable.

2. To Increase Liquidity in the Market

Liquidity refers to the ability to buy or sell shares without causing a significant price change. By splitting the stock, a company increases the number of shares available in the market, which can improve liquidity.

-) A higher number of shares and a lower price per share can attract more buyers and sellers in the stock market.

-) This increased trading activity can help investors enter and exit their positions with ease.

For example, in the Indian stock market, Infosys may decide to split its stock to ensure better liquidity in the shares. Increased liquidity is often considered a good sign for investors, as it indicates healthy market activity.

3. To Attract New Investors

When a company announces a stock split, it often generates positive media coverage and grabs the attention of potential investors.

-) The company may be trying to attract more retail investors who might have been deterred by the high price of its shares.

-)  A stock split can also create a psychological effect, where investors see the lower share price as an opportunity to buy at a "discounted" rate, even though the total value of the investment remains the same.

In the Indian stock market, Reliance Industries or HDFC Ltd. may announce a stock split to ensure that they are attracting new investors who can benefit from the company’s strong performance but were previously hesitant due to the high share price.

4. To Signal Confidence in the Company’s Future Growth

A stock split is often viewed as a positive signal from a company about its future growth and profitability. When a company’s stock price has been rising consistently, it can signal to the market that the company is confident in its long-term prospects.

-) Companies typically announce a stock split when they are doing well financially and believe that the stock price will continue to grow.

-)This can instill investor confidence and even attract institutional investors who may see the stock as a potential growth opportunity.

For example, a company like HDFC Bank, with consistent growth in earnings, might announce a stock split to signal its optimism about the future and its ability to continue delivering strong results.

5. To Maintain the Stock Price within a Certain Range

Some companies like to keep their stock price within a specific range, typically between ₹100 to ₹2,000 per share.

-) Keeping the price within this range ensures that the stock remains attractive to both retail and institutional investors.

-) It helps avoid the stock becoming too expensive (which can discourage investors) or too cheap (which can make it seem risky).

For instance, a company like Bajaj Finance may announce a stock split to keep its share price at a reasonable level, ensuring it remains appealing to a large number of potential investors in the Indian market.

6. To Align with Market Practices

Sometimes, companies announce stock splits simply because it is a common practice, especially among large-cap or well-established companies.

A stock split may be seen as a natural part of a company’s growth trajectory, and it helps align the company with the broader market. This is often the case with blue-chip companies like Maruti Suzuki, Larsen & Toubro, and ICICI Bank.

Announcing a stock split is also a way for companies to communicate that they are stable, performing well, and ready to make their stock more accessible to a wider investor base.

Impact of Stock Split on Shareholders

For shareholders, a stock split offers no immediate financial benefit. However, there are several potential long-term effects:

-) More Shares, Same Value: After a stock split, shareholders will own more shares, but the price per share will be adjusted, leaving the overall value of their holdings unchanged.

-) Increased Liquidity: More shares in circulation can make it easier to buy and sell, which can be beneficial for investors looking to trade.

-) Possible Price Appreciation: While the value of your investment doesn’t change immediately, the lower stock price may attract more investors, potentially pushing the price higher in the long term.

Example of Stock Split in the Indian Market

Reliance Industries Ltd. announced a stock split in the past to make its shares more affordable. Suppose the stock price of Reliance Industries was ₹3,000, and they announced a 2-for-1 stock split:

-) If you had 100 shares, you would now have 200 shares, but the price per share would adjust to ₹1,500.

-) The total value of your investment would remain the same, but the stock would be more accessible to retail investors.

Conclusion

A stock split is a useful corporate action for companies to make their shares more affordable, increase liquidity, and signal confidence in their future growth. While the split doesn’t affect the overall value of your investment, it can create opportunities for more investors to buy into the company.

At RISEVESTORS, the best stock market institute in Meerut, we equip our students with in-depth knowledge about stock splits, stock market strategies, and other important concepts that help them navigate the dynamic world of investments. If you’re looking for the best stock market course in Meerut, our experienced tutors and mentors are here to guide you every step of the way.

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Disclaimer: This blog is intended for educational purposes only. Please consult a financial advisor before making any investment decisions.