Knowing What Stock Splits Mean
Stock splits may appear like an advantageous process for some investors, however, there is an inadequate indication that you benefit in any meaningful way when a company splits its stocks.
WHAT IS A STOCK SPLIT?
A stock split, also known as a forward stock split, refers to a corporate action that increases or decreases its total number of shares outstanding without changing the firm’s market value or the fair ownership interest of existing shareholders. This process, which needs advance approval from the company’s board of directors, commonly involves the declaration of further shares to existing shareholders.
The most common split ratios are 2-for-1 or 3-for-1, which means that the stockholder will have two or three shares, respectively, for every share held earlier. In the UK, a stock split is known as scrip issue, bonus issue, capitalization issue or free issue.See also Difference Between Economic Value Added and Market Value Added
WHY DO COMPANIES CHOOSE TO STOCK SPLIT?
Sometimes the price of a company’s share increases so much that it may dishearten investors from buying them. So, the company chooses to lessen the price per share with a stock split. This also helps the company lift its overall liquidity as new investors may get interested in buying shares.
ORDINARY STOCK SPLITS
The most common reason why a company bothers to do an ordinary stock split is that its management believes the stock is too expensive, so it wants to lower the cost of the stocks to make them more affordable and therefore more attractive to new investors.
REVERSE STOCK SPLITS
This commonly occurs when a company’s management wants to increase the stock price. While the ordinary splits can occur when the management believes the price is too expensive, in a reverse stock split, it means the company feels that the stock price is too cheap. If the price of a stock looks too low, that may discourage interest by individual or institutional investors. Management wants to get more interest in the stock for the benefit of shareholders.
One absolute negative reason for a reverse stock split is if the company’s stock is susceptible to being delisted. If a stock is on a major exchange and the price drops below $1, the stock will face delisting. A reverse split may be useful to prevent such event.
ADVANTAGES TO INVESTORS
There are a few arguments over whether a stock split is an advantage or disadvantage to investors. There are some say that a stock split is a good buying indicator, indicating the company’s share price is growing and therefore doing very well. This may be true, but on the other hand, a stock split simply has no impact on the market value of the stock and therefore carries no real benefits to investors. Despite this fact, investment newsletter noted of the often positive sentiment surrounding a stock split. There are whole publications dedicated to detecting stocks that split and attempting to profit from the bullish nature of the splits. Critics would say this technique is by no means a time-tested one and is doubtfully successful at best.See also How to Spot a Successful Company for Stock Picking
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