March 02, 2018

How investors can gain from company stock splits



A stock split is a process by which a company increases its number of outstanding shares by splitting its shares in a pre-determined ratio like 2 for 1 stock. This ratio is decided prior to split by the senior executives and board of directors of the company.
   
It is often observed that a few companies split their stocks creating a buzz in the market. Why is the splitting done? Does this splitting impact the investors holding the shares, and if so how? These are certain questions that everyone thinks about at one point or other. But before we seek for the answers of these questions, let us first understand what a stock split is.

What is a Stock Split?

A stock split is a process by which a company increases its number of outstanding shares by splitting it shares in a pre-determined ratio like 2 for 1 stock. This ratio is decided prior to split by the senior executives and board of directors of the company. However, the net value of the outstanding shares remains the same.

This looks somewhat like you had Rs100 and you got it changed for two Rs50 notes. Here the net value of the currency you hold remains the same but the number of notes you hold has now increased.

How does it impact the value?

From investor’s point of view, it looks like if you hold 10 shares worth Rs1,000, where each share would worth Rs100. If there is a split of 2 for 1 shares, you will now hold 20 shares worth Rs1,000, but now the cost of each share has halved to Rs50 a share.

This clearly means there is no change in the total value of the shares, but yes, the cost of a single share varies (gets cheaper) and the total number of shares increases, resulting in a higher number of outstanding shares from the company’s perspective. This would definitely improve the liquidity.

How can the investors gain from the company stock splits?

Although as you have seen the value of the shares remains the same as described in the above examples. Then how can investors benefit out of the stock splits?

There are two things which make the difference here.

Firstly, it creates a psychological impact on the investors, that they now hold more shares for the same cost. This definitely does not create any impact when seen theoretically, but yes practically one could observe more movements within the market. This results in a price rise as observed in many of the previous cases. Though the reason for this rise is completely behavioral and is still under research to understand the pattern.

Secondly, now that the price of a single share is lower, the shares of big chip companies which were earlier available at higher prices are now more affordable. This would help more investors to trade flexibly with more shares in their hand and a lower per share price. This fast-paced movement in the market might cause an upward movement in the price of the stocks. This often happens during bearish markets.

Being an investor if you are looking to gain from the company stock splits, all you could do now is easily trade with the surplus shares while still holding some. This not only disperses the risk but also helps you get more margins out of the frequent trades you do with these shares especially when the market seems bearish.

Thus, by gearing up your trading and buying furthermore the number of shares at lower per share cost you could actually gain from the company stock splits.

 

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