What are Stock Splits?
When companies initially go public, banking institutions determine the value and number of shares a company’s stock would be. If the company becomes profitable, the company may decide to increase the number of shares available. Some companies do this by diluting stocks but another great way to do it is by splitting stocks.
What is a Stock Split?
Corporate entities may decide to increase the number of available shares by offering a 2-for-1 or many for a few stocks. When this happens, it is known as a stock split. With a stock split, existing shareholders receive say a double of their shares, they then trade some to others, by giving room for more investors and driving up the demand and the value of the stocks.
The difference with stock dilution
Stock dilution increases the number of shares overall but does not provide more shares to the shareholders, meaning the value of the stock becomes diluted or less than before. Companies do that generally for growth and to get huge capital.
Stock splits provide more shares to the stakeholders and do not dilute the stock value but increase the number of shares available to shareholders to increase share liquidity and affordability.
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Impact of Stock Splitting into Investors and Companies
Stock splits reduce the price per share but increase the number of shares available to shareholders meaning the investors’ total share value remains constant whilst the number of shares increases. At least, that is what happens initially. After a while, the reduction in price per share and affordability would lead to increased market demand which would also lead to an increase in stock value.
Stocks can be split as 2-for-1, 3-for-1, 4-for-1, and so on. This causes stock prices to be cut in half or by a third, or by four, respectively. However, they are the same shares, it’s just that they are split up. The new stock prices can be calculated by dividing the current stock price by the split ratio.
After the stock price decreases, a sharp price increase would be witnessed as low-budget investors cash in on the possibility of purchasing stock in the companies offering the stock split. The stock split then represents a crucial reset of the increased price of the stock with the assumption that the company’s success would continue to drive the price up.
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The reverse can happen in what is aptly referred to as a reverse stock split. This is where a company decreases the number of its shares. This is usually done to increase the price per stock for companies to look favorable in the market, remain competitive and avoid being delisted from the stock exchange. Companies can be removed from the stock exchange if their stock prices go too low.
Conclusion
A stock split would not affect the total value of your stocks. It just increases the number of your stocks and decreases the value of each stock for a short time. The company’s value remains unchanged and short-sellers are not necessarily affected by stock splits.
Stock splits are less common than they were in the past, but when they happen, it can give you an opportunity to become an investor in the company issuing the stock split.
