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Stock Split



Definition

A stock split is a corporate decision to increase the number of available shares by dividing the existing shares into multiple ones. This action doesn’t alter the company’s market capitalization, which means the total value of the shares remains the same despite the increase in number of shares. It is often done to make shares more affordable for retail investors and increase liquidity.

Phonetic

The phonetics of the keyword “Stock Split” is: /stɑk splɪt/

Key Takeaways

Three Main Takeaways About Stock Split

  1. Increases Liquidity: A stock split increases the number of shares outstanding, thus potentially increasing the liquidity of the stock. This is because the lower price per share makes it more affordable for a larger number of investors.
  2. Doesn’t Affect Company’s Value: A stock split does not change a company’s overall market value. While the number of shares outstanding increases and the price per share decreases, the total market capitalization remains the same.
  3. Positive Signal to Market: Companies often resort to stock splits when the price of their stocks is very high. This is usually viewed as a positive signal by the market because high-priced stocks are often those of successful companies.

Importance

A stock split is significant in business and finance as it can make shares seem more affordable to small investors, thus potentially expanding a company’s investor base. During a stock split, a company increases the total number of its outstanding shares while the price of each share decreases proportionally, ensuring the company’s market capitalization remains the same. This maneuver can also create the perception of growth potential which may boost investor confidence and raise the company’s share price in the long term. Also, a higher share volume can contribute to increased liquidity, ensuring investors can buy or sell shares more easily.

Explanation

A stock split serves a critical function in the financial world as a tool that companies use to manage the liquidity of their stocks in the market. By doing a stock split, companies can increase their shares’ availability in the market without altering the shareholders’ total equity. This strategy often aims at making the stocks more affordable for small investors, who may have been priced out when the share prices were high. Lower priced shares can be traded more easily, thus increasing the stock’s liquidity. Increased liquidity can then lead to a more efficient market for the company’s shares.The utilization of a stock split can also send a positive signal about the future prospects of the company. When a stock split is announced, the market perceives it as the company’s confidence in its future performance, that the company’s management believes the shares price will continue increasing. However, a stock split doesn’t inherently alter a company’s valuation, as it won’t affect the company’s total market capitalization. It simply divides the existing pie into smaller, more affordable slices. Hence, stock split can be viewed as a psychological strategy to appeal more to small investors.

Examples

1. Apple Inc.: Apple has split its stock four times since it went public. One of the most significant splits happened in 2014 when the company declared a 7-for-1 stock split. Before the split, Apple’s stock price was about $700 a share. After the split, the stock price was reduced to $100 per share. So if an investor had one share before the split, they ended up with seven shares post-split, maintaining the same overall value but having a more affordable price.2. Tesla Inc.: In 2020, Tesla announced a 5-for-1 stock split which came into effect in August 2020. Investors who owned one share of Tesla stock before the split owned five shares afterward. The price per share decreased accordingly, becoming more affordable for smaller investors and potentially broadening the company’s investor base.3. Amazon.com Inc.: While the company has not split its stock since 1999, the three splits it carried out between 1998 and 1999 are notable examples. In 1999, Amazon’s shares were split 2-for-1, meaning that for each share an investor held, they received two. This made the shares more accessible to individual investors, as the price per share was halved.

Frequently Asked Questions(FAQ)

What is a stock split?

A stock split is a corporate action where a company increases the number of its outstanding shares by issuing more shares to its current shareholders.

Why do companies carry out a stock split?

Companies typically carry out stock splits to make their shares more affordable and increase liquidity.

How does a stock split affect a stock’s price?

A stock split causes the price of individual shares to drop. For instance, in a 2-for-1 stock split, the stock’s price will be halved.

Does a stock split change a company’s overall market value?

No, a stock split does not alter a company’s overall market value. It merely increases the number of outstanding shares while decreasing the price of each individual share.

What is the difference between a stock split and a stock dividend?

While both stock splits and stock dividends increase the number of shares, a stock dividend raises the number of shares by giving it to shareholders as a dividend, whereas a stock split simply divides the current shares.

Does a stock split impact the value of my current investment?

A stock split in itself does not directly change the total value of your investment. Even though the number of shares you hold increases, the price per share decreases accordingly hence maintaining the total investment value.

How does a stock split affect earnings per share?

After a stock split, earnings per share decrease because the earnings will now be divided among a larger number of shares.

Can a company reverse a stock split?

Yes, a company can reverse a stock split. This is known as a reverse stock split and it decreases the number of shares by increasing the price per share.

Related Finance Terms

Sources for More Information


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