Definition
A stock split refers to an increase in a corporation’s number of outstanding shares of stock, aimed at making the stock more marketable without any change in overall shareholders’ equity or the total market value at the time of the split. During a stock split, which is also called a split-up, the per-share price of the stocks typically decreases proportionally.
For example, in a 2-for-1 stock split, the number of authorized shares doubles (e.g., from 10 million to 20 million), while the price per share drops by half. If the original share price was $100, it would become $50 after the split. Consequently, a shareholder owning 50 shares before the split would now possess 100 shares, each valued at $50. Additionally, dividends per share fall proportionately post-split.
Examples
- 2-for-1 Split: A company has 1 million shares outstanding priced at $80 each. After a 2-for-1 split, the number of shares becomes 2 million, and each share is priced at $40.
- 3-for-1 Split: A company has 500,000 shares outstanding priced at $90 each. After a 3-for-1 split, the number of shares becomes 1.5 million, and each share is priced at $30.
- Reverse Split: A company has 10 million shares priced at $5 each. If it undergoes a 1-for-5 reverse split, the number of shares reduces to 2 million, while the share price increases to $25 each.
Frequently Asked Questions (FAQs)
1. What is the purpose of a stock split?
A stock split is usually conducted to make shares more affordable and attractive to small investors by lowering the share price, which can lead to improved liquidity in the market.
2. Does a stock split affect the company’s market capitalization?
No, a stock split does not affect a company’s market capitalization. Before and after the split, the overall value of the company remains unchanged, although the number of shares and the price per share are adjusted proportionately.
3. Do dividends change after a stock split?
Yes, dividends per share will decrease proportionately after a stock split. However, the total dividend payment by the company remains the same.
4. Are all splits the same?
No, stock splits can vary. Common forms include 2-for-1, 3-for-1, or even reverse splits such as 1-for-5. In a reverse split, fewer shares are traded at a higher price.
5. Does a stock split signal a strong company performance?
Not necessarily. While stock splits often occur when a company’s share price has significantly risen, they are more a decision on marketability rather than directly indicating company performance.
Related Terms
- Reverse Stock Split: Reducing the number of a company’s shares and increasing the share price proportionally to increase its trading value and meet market requirements.
- Market Capitalization: The total market value of a company’s outstanding shares, calculated by multiplying the current share price by the total number of outstanding shares.
- Dividends: Payments made by a corporation to its shareholders, usually as a distribution of profits.
Suggested Online References
Suggested Books for Further Studies
- “The Intelligent Investor” by Benjamin Graham
- “Common Stocks and Uncommon Profits” by Philip Fisher
- “One Up On Wall Street” by Peter Lynch
- “A Random Walk Down Wall Street” by Burton G. Malkiel
Fundamentals of Stock Splits: Corporate Finance Basics Quiz
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