Stocks or shares are the basic entities of <b><a href="http://www.kotaksecurities.com/home/" title="Stock Market">Share market</a></b>. It is important to understand the fundamentals of stock splits as the stock price is determined by the distribution of companies capital on the whole. Understand the concept of stock splits and reverse splits. Also understand how stock split help make shares more affordable to small investors and provide greater marketability & liquidity in the market with Kotak Securities - India’s largest <b><a href="http://www.kotaksecurities.com/aboutus/index.html" title="Share Broker">stock brokerage firm</a></b>.
DEFINITION“A corporate action in which a companys existing shares are divided into multiple shares. Although the number of shares outstanding increases by a specific multiple, the total dollar value of the shares remains the same compared to pre-split amounts, because no real value has been added as a result of the split.” - Investopedia
INTRODUCTIONAll publicly-traded companies have a set number of shares that are outstanding onthe stock market. These shares are nothing but sub division of capital.So if a companys capital is Rs. 10 crore divided into 1 crore shares of Rs 10 eachthan this Rs. 10 is called the face value of the share.When this share is traded at the stock market, this value may go up or down,depending on the supply and demand for the stock. If everyone wants to buy theshares, the price will go up and nobody wants to buy them and many want to sellthe shares, the price will fall.This demand and supply driven price of the share in the market at any point oftime is called the price of the share or the market value of a share. So the sharewith a face value of Rs 10 may be quoted at Rs 1000 and this will be its marketprice.
A stock split is a decision by the companys board of directors to increasethe number of shares that are outstanding by issuing more shares tocurrent shareholders. For example, in a 2-for-1 stock split, everyshareholder with one stock is given an additional share. So, if a companyhad 1 crore shares outstanding before the split, it will have 2 crore sharesoutstanding after a 2-for-1 split. But at the same time face value of theshare is also reduced by half. So, if earlier the face value was Rs 10, after astock split of 2-for-1 it will reduce to Rs 5 per share. A shares market priceis also affected by a stock split. After a split, the stock price will bereduced since the number of shares outstanding has increased. In theexample of a 2-for-1 split, the share price will be halved. Thus, althoughthe number of outstanding shares and the stock price change, the marketcapitalization remains constant.
Stock splits are usually done by companies who have seen their stockprices rise to extremely high levels or are much higher compared tosimilar companies within their sector. Once the stock is split the overallcost of the stock too will be reduced.For e.g. A 2 for 1 stock split will ensure that the stock split will be halved.The primary aim of the split is provide small investors with an option ofbuying shares of the company without impacting underlying value of theorganization.
WHAT HAPPENS AFTER THE SPLIT?A stock split can also result in a stock price increase following thedecrease immediately after the split. Since many small investors think thestock is now more affordable and buys the stock and they end up boostingdemand and driving up the prices.The Securities and Exchange Board of India had issued a guideline askingthat only companies with a stock price of greater than Rs.500 would beallowed to do a stock split.
REVERSE SPLITReverse split is another version of the stock split. This option is used bycompanies who have lower share prices and would like to increase theirprices and get respectability in the market or to prevent their companyfrom being delisted.
CONCLUSIONThe bottom line is that a stock split is used primarily by companies thathave seen their share prices increase substantially and although after thesplit the number of outstanding shares increases and price per sharedecreases, the market capitalization (and the value of the company) doesnot change. As a result, a stock split help make shares more affordable tosmall investors and provides greater marketability and liquidity in themarket.
Thank You! Read More Questions? Feedback? Click on any of these -Twitter Website Facebook
• Registered office: Kotak Securities Limited, 1st Floor, Bakhtawar, 229, Nariman Point, Mumbai - 400021. SEBI Registration No: NSE INB/INF/INE 230808130, BSE INB 010808153/INF 011133230/INE 011207251, OTC INB 200808136, MCXSX INE 260808130.• Disclaimer: Investments in securities are subject to market risks, please read the SEBI prescribed Combined RDD prior to investing.• * Awarded Best Brokerage Firm in India by AsiaMoney in 2006, 2007, 2008 and 2009