A stock split is re-proportioning of the face value of a stock in a ratio determined by the company. So, if a stock with the face value of `10 is split in the ratio of 2:1, its face value would be `5per share, post the split. Effectively, its price will also change. If the price of the stock prior to the split was `400, it will now be `200 per share.
The company announces the split ratio on a particular date (typically, while announcing its quarterly or annual results or during the annual general meeting), called the record date. All shareholders, as on this date according to records, are credited with the additional shares. A few days later, the stock starts trading on the exchanges at the ex-split or post-split price.
Why do companies opt for it?
The decision is taken by the board of directors to increase the number of shares that are outstanding, available for public trading, by issuing more shares to current shareholders. It is done by companies, which have seen their share prices rise to levels either too high for retail investors or beyond the price levels of their peers. The price after the split makes the shares seem more affordable to small investors, though the fundamentals of the company remain unchanged. This also boosts the liquidity of the scrip, making it widely held.
How does the split affect the stock price?
Technically, a stock split does not change the value of the stock or give the existing investors any additional incentive, as the underlying value of the company continues to be the same. Therefore, the price of the share gets adjusted and the earnings per share comes down commensurately after the split. However, a split can result in the stock price moving up, since many more small investors can buy the stock that is more affordable. In the process, the demand for the stock drives up its prices. Another factor that can lead to a price rise after the split is that it provides a signal to the market that the company's share price has been increasing, necessitating a split. People may assume this growth will continue in the future and again lift demand and prices.
Does it offer opportunities to retail investors?
After the split, as the price of the stock is perceived to be cheaper, it may move fast. Retail investors can use the opportunity to re-balance or diversify their portfolio. They could buy blue-chip stocks that are otherwise highly priced. Similarly, it also gives investors an opportunity to exit underperforming stocks partly or fully.
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