A stock split is a corporate action which splits the existing shares of a particular face value into smaller denominations so that the number of shares increase but the market capitalization continues to remain the same.
For Example a company has issued 10,000,000 shares with a face value of $ 10 and the current market price being $100, a 2-1 stock split would reduce the face value of the share to $5 and the number of company’s outstanding shares to 20,000,000. Consequently the share prices will also half to $50 so that the market capitalization or the value of the shares held by the investors remains the same.
Considering the same example if a 5-1 stock split is considered we will expect a shareholder having 1 share to have 5 shares of the same value. Thus the stock is split into 5 parts with a face value of $2 and market capitalization of $50,000,000 and consequently the current market price to be $20.
So are these stock splits good or bad?
From the company point of view stock splits are good as they indirectly play with the investors sentiments in the following way.
As the price of the security (a well traded one) goes higher and higher, some small time investors feel that the price is too high for them to afford hence a stock split will bring down the face value of the stock and also the current market price, just as we saw in the first example. This method brings the stock prices to an attractive level and targets the investors on the right spot.
Secondly, splitting stocks may lead to increase in the liquidity of the markets since more investors are keen on buying the stock and also the number of outstanding shares increase in the market.
From the investor point of view a stock split indicates that the share is performing extremely well in the market but before investing a background check would do no harm.
Investing before the split would ideally be a good step as one should not ignore the broking charges which come in the picture.
On the whole a stock split is a good option for companies whose stock prices have sky rocketed and an urgent need to retain the investors and attract new one’s is on the radar.