What Is Stock Split: Why Companies Split Their Stocks

When a company is concerned that its share price is pricey and wants to make the shares affordable, the corporate action it opts for is a Stock Split/Subdivision of shares. A stock split helps companies to appeal to new investors without any addition to the market cap. Let us see how a stock split works and how it impacts investors.

What is a stock split?

A stock split is when a company issues more shares to its current shareholders by lowering the face value of each share at a specified ratio. It means that the number of outstanding shares is increased by dividing the existing shares originally issued to the present shareholders. Though there is an increase in the number of shares, the overall market capitalization of the company and the value of each shareholder’s stake remain the same.

As mentioned above, the stock split happens in a specified ratio. For example, if the ratio is 1:5, it means that for every one share held the shareholder will get 5 shares respectively.

Let us see illustrations in the below table to find the changes in the number of shares, share price and the face value of the share before and after the split for different ratios

Before Split

After Split

Stock split No. of shares held Share Price Face Value Value of Investment No. of shares held Share Price Face Value Value of Investment
1:2 10 900 10 9000 20 450 5 9000
1:5 10 900 10 9000 50 180 2 9000

Remember that in a stock split, the face value of the share decreases by the ratio of the split.

How does a stock split affect you?

If you are an existing shareholder, a stock split may appear to have no noticeable effect but it eases your portfolio management and provides more liquidity with an increase in the number of shares

If you are not a shareholder of the company that went for a stock split, you have an opportunity to buy the shares now at a lower price than before.

For example, if IRCTC’s share price was at ₹ 4500. After a stock split in the ratio of 1:5 in Oct-22, the share price of IRCTC would become ₹900 making it affordable for new investors and giving the existing shareholders flexibility to manage their portfolios.

Key dates in a stock split

Record date is the date on which the company checks its records to identify the eligible shareholders for a stock split.

Ex- split date– is the date on which the stock starts trading at the new adjusted split price.

The sub-divided shares will be credited with the new ISIN to the existing shareholders on the immediate next trading day after the record date.

Adjustment of Future & Options contract due to a stock split

After the stock split, the market lot and strike price for F&O contracts with the stock as underlying security will be revised by calculating the adjustment factor.

Adjustment factor for Stock split of A: B is defined as (B/A). In the case of a stock split ratio of 1:5, the adjustment factor is (5/1) = 5.

1. Futures/Strike Price: The adjusted futures/strike price will be arrived at by dividing the old futures/strike price by the adjustment factor.

2. Market Lot: The adjusted market lot will be arrived at by multiplying the old market lot with the adjustment factor

Let us consider the example of Jubliant Food Works that went for a stock split in the ratio of 1:5 in April 2022.

Before Adjustment:

Instrument Security Symbol Expiry Date Strike Price (₹) Option Type Long Position Short Position
OPTSTK JUBLFOOD 28/Apr/22 2750 PE 0 125
OPTSTK JUBLFOOD 28/Apr/22 2750 CE 125 0

After Adjustment:

Instrument Security Symbol Expiry Date Strike Price (₹) Option Type Long Position Short Position
OPTSTK JUBLFOOD 28/Apr/22 550 PE 0 625
OPTSTK JUBLFOOD 28/Apr/22 550 CE 625 0

Remember that the investment value/ contract value of a future or options contract remains same after adjustment, due to a stock split.

What is Reverse Stock Split?

A reverse stock split is when a company reduces the number of outstanding shares by increasing the face value of the share, without diluting the market cap. As in a stock split, the value of investment of the shareholder remains unaffected by a reverse stock split.

Let us see an example of how reverse stock split works

Say, you hold 10 shares of a company XYZ at a share price of ₹ 50. The total value of your investment in XYZ becomes ₹ 500.

The company XYZ goes for reverse stock split in the ratio of 2:1. After the reverse stock split, you will now hold only 5 shares of XYZ. But the value of each share will now increase to ₹100, keeping your total investment at ₹ 500 like before.

It is important to remember that a stock split makes a share affordable to new investors and provides flexibility to existing shareholders with a decrease in share price and an increase in the number of shares respectively. If you are watching a particular stock and if it goes for a split, it may provide you an opportunity to buy that stock at a lower price than before. The other corporate action in which the number of outstanding shares of a company increase is the Bonus Issue. Click here to know the differences between bonus shares and stock splits.

Disclaimer: This blog is exclusively for educational purposes.

FAQs

What is stock split?

A stock split is a corporate action that involves dividing existing stocks into multiple shares. It increases the number of shares, but the value of the total shares remains unchanged. Companies issue stock splits at a fixed ratio. For example, in a stock split of 2:1, each shareholder receives 2 shares for every one they previously held. 

Why do companies perform stock splits?

Companies primarily perform stock splits to make stocks more affordable. It helps increase liquidity in the market. Lower share prices help attract more investors and potentially boost trading volume. It can boost the perceived affordability of the stock and improve market perception.

Is stock split good or bad?

Stock splits are usually beneficial for investors. Although it doesn’t create a direct financial gain or loss, in most cases, splits indicate that the company is confident about its position and seeking more capital to fuel its future growth. A stock split lowers the price per share, which helps attract more investors and improve liquidity for existing shareholders. 

How does the stock split affect shareholder value?

A stock split is usually considered neutral for shareholders. A stock split doesn’t have a direct impact on the shareholder’s value. However, as the number of shares increases, the share price due to the stock split decreases proportionally.