What Is Stock Split: Why Companies Split Their Stocks

When a company is concerned that its share price is pricey and wants to make the shares affordable, the corporate action it opts for is a Stock Split/Subdivision of shares. A stock split helps companies to appeal to new investors without any addition to the market cap. Let us see how a stock split works and how it impacts investors.

What is a stock split?

A stock split is when a company issues more shares to its current shareholders by lowering the face value of each share at a specified ratio. It means that the number of outstanding shares is increased by dividing the existing shares originally issued to the present shareholders. Though there is an increase in the number of shares, the overall market capitalization of the company and the value of each shareholder’s stake remain the same.

As mentioned above, the stock split happens in a specified ratio. For example, if the ratio is 1:5, it means that for every one share held the shareholder will get 5 shares respectively.

Let us see illustrations in the below table to find the changes in the number of shares, share price and the face value of the share before and after the split for different ratios

Remember that in a stock split, the face value of the share decreases by the ratio of the split.

How does a stock split affect you?

If you are an existing shareholder, a stock split may appear to have no noticeable effect but it eases your portfolio management and provides more liquidity with an increase in the number of shares

If you are not a shareholder of the company that went for a stock split, you have an opportunity to buy the shares now at a lower price than before.

For example, if IRCTC’s share price was at ₹ 4500. After a stock split in the ratio of 1:5 in Oct-22, the share price of IRCTC would become ₹900 making it affordable for new investors and giving the existing shareholders flexibility to manage their portfolios.

Key dates in a stock split

Record date is the date on which the company checks its records to identify the eligible shareholders for a stock split.

Ex- split date– is the date on which the stock starts trading at the new adjusted split price.

The sub-divided shares will be credited with the new ISIN to the existing shareholders on the immediate next trading day after the record date.

Adjustment of Future & Options contract due to a stock split

After the stock split, the market lot and strike price for F&O contracts with the stock as underlying security will be revised by calculating the adjustment factor.

Adjustment factor for Stock split of A: B is defined as (B/A). In the case of a stock split ratio of 1:5, the adjustment factor is (5/1) = 5.

1. Futures/Strike Price: The adjusted futures/strike price will be arrived at by dividing the old futures/strike price by the adjustment factor.

2. Market Lot: The adjusted market lot will be arrived at by multiplying the old market lot with the adjustment factor

Let us consider the example of Jubliant Food Works that went for a stock split in the ratio of 1:5 in April 2022.

Before Adjustment:

After Adjustment:

Remember that the investment value/ contract value of a future or options contract remains same after adjustment, due to a stock split.

What is Reverse Stock Split?

A reverse stock split is when a company reduces the number of outstanding shares by increasing the face value of the share, without diluting the market cap. As in a stock split, the value of investment of the shareholder remains unaffected by a reverse stock split.

Let us see an example of how reverse stock split works

Say, you hold 10 shares of a company XYZ at a share price of ₹ 50. The total value of your investment in XYZ becomes ₹ 500.

The company XYZ goes for reverse stock split in the ratio of 2:1. After the reverse stock split, you will now hold only 5 shares of XYZ. But the value of each share will now increase to ₹100, keeping your total investment at ₹ 500 like before.

It is important to remember that a stock split makes a share affordable to new investors and provides flexibility to existing shareholders with a decrease in share price and an increase in the number of shares respectively. If you are watching a particular stock and if it goes for a split, it may provide you an opportunity to buy that stock at a lower price than before. The other corporate action in which the number of outstanding shares of a company increase is the Bonus Issue. Click here to know the differences between bonus shares and stock splits.

Advantages of Stock Splits

Conducting a stock split offers several benefits for both the company and its investors. Here’s a breakdown of the key advantages of a stock split:

1. Boosts Liquidity: Splitting the stock enhances the total shares available in the market, potentially raising the trading volume of the stock. An increase in the number of shares traded can boost liquidity, facilitating easier buying and selling of the stock for investors.
2. Welcomes New Investors: Post-split, the reduced price per share can open up the stock to a broader investor base, which may have found the pre-split price too prohibitive. This can heighten demand for the stock and draw in new investors, potentially elevating the stock’s value.
3. Creates a Sense of Affordability: By splitting its stock, a company can alter investor perception, making its shares seem more affordable. For instance, a stock priced at ₹1,000 might seem out of reach for some, but after a 2-for-1 split, the new price of ₹500 per share may appear more attainable.
4. Enhances Market Capitalisation: When a company splits its stock, the increased number of shares can lead to a rise in the company’s market capitalisation. This might appeal to institutional investors who might have previously bypassed the company due to its smaller market cap.

Disadvantages of Stock Splits

Here are a few key downsides of a stock split that businesses and investors might want to keep in mind:

1. No Impact on Company Worth: When a stock is split, it doesn’t alter the fundamental value of the business. The total market value, earnings, and basic financial health of the company stay the same before and after the split.
2. Increased Fluctuation: A stock split may lead to greater fluctuations in the stock’s price, potentially causing wider gaps between the buying and selling prices and more pronounced short-term price changes.
3. Sign of Financial Troubles: Sometimes, if a company decides to split its stock, it might be seen as struggling financially or not being confident about its future prospects. Such a view could negatively impact its stock price and how investors feel about the stock.

Example of Stock Splits

A notable example of a stock split in India from recent times involves Hindustan Aeronautics Ltd (HAL), which underwent a stock split in a 1:2 ratio. This split was approved by HAL’s board, aiming to make the shares more accessible to a wider range of investors. As a result of the split, each existing equity share of HAL with a certain face value was divided into two shares, halving the face value of each share.

Before the stock split, the shares were performing robustly in the market. Following the announcement and completion of the stock split in a 1:2 ratio, HAL’s shares opened higher at ₹3739.50 on the BSE and experienced significant growth over the year. Specifically, the stock saw a 107% rise in one year, a 258% increase over two years, and more than a 400% increase over three years​​.

BCL Industries also underwent a stock split, where one share with a face value of ₹10 was split into 10 shares with a face value of ₹1 each. Before the split, BCL Industries shares were in a base-building mode and had lost over 11% in one month. However, in the six months leading up to the split, the share price ascended from around ₹425 to ₹480 apiece levels, delivering a return of approximately 12% to its shareholders. In the year-to-date (YTD) period up to the split, BCL Industries’ share price rose from around ₹324 per share levels to ₹480 per share levels, registering a rise of nearly 50%​​.

Conclusion

Stock splits can make shares more accessible to a wider range of investors, potentially increasing a company’s stock liquidity. While this offers advantages like making shares appear more affordable and enhancing trading volumes, it’s essential to understand that the intrinsic value of the company remains unchanged. For those intrigued by the dynamics of stock splits and looking to dive into the stock market, opening a Demat account with Angel One could be a strategic first step. Ready to embark on your investment journey? Explore Angel One for more details on how to get started.

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