Stock Splits Definition
Stock split, also known as share split, is the way through which the companies divide their existing outstanding shares into multiple shares such as 3 shares for every 1 share held or 2 shares for every 1 held etc. Market capitalization of the company during stock split remains the same, even though the number of shares increases, there is a corresponding decrease in price per share.
Did you wonder when Yes Bank Share prices reduced by 80% on 21 September 2017? It was an example of a share split by the Bank. Yes bank split the shares in the ratio of 5 for 1 on the above date.
In this case, the total number of outstanding shares of the bank increased by 5 times, and share price reduced to the same extent, thereby leaving Market Capitalisation at the same figure of Rs. 85,753.14 Crs.
Types of Stock Splits
There are two types –
- Forward Splits
- Reverse Splits
The above example of Yes bank is that of Forward splits. In an exactly opposite manner, if a company decides to reduce the outstanding number of shares and thereby increase the share price proportionately, it becomes Reverse Stock Splits.
Stock Split 2 for 1
Stock Split 2 for 1 essentially means that there will now be two shares instead of 1. For example, if there were 100 shares and the issued price was $10, with the market capitalization of 100 x $10 = $1,000. If the company splits for 2 for 1, then the total number of shares will double to 200. The effective share price will be $1000/200 (Market cap/shares) = $5 per share.
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2 for 1 Example
- We note from below that Jewett-Cameron announces 2 for 1 Stock Split.
- Management believes that the share split is expected to increase the liquidity of shares and will facilitate any new repurchase program in the future.
- Also, the 2 for 1 stock split will result in doubling the number of shares to 4,468,988
Stock Split 3 for 1
Stock Split 3 for 1 means that there will be three shares now instead of 1 share. For example, if there were 100 shares and the issued price was $10, with the market capitalization of 100 x $10 = $1,000. If the company splits for 3 for 1, then the total number of shares will triple to 300 shares. The effective share price will be $1000/300 (Market cap/shares) = $3.33 per share.
3 for 1 Example
- Cameo Resources Corp has planned a 3 for 1 Stock Split.
- Post 3 for 1 split, Cameo will have 55,674,156 shares outstanding.
Stock Split 3 for 2
Stock Split 3 for 2 means that there will be three shares for every two shares. For example, if there were 200 shares and the issued price was $20, with the market capitalization of 200 x $20 = $4,000. If the company splits for 3 for 2, then the total number of shares will now become 300 shares. The effective share price will be 4000/300 (Market cap/shares) = $13.33 per share.
3 for 2 Example
- Horizon Bancorp Inc has planned for a 3-for-2 Stock Split.
- 3 for 2 split will increase Horizon’s outstanding shares from approximately 25.6 million shares prior to the split to approximately 38.4 million shares
Reasons for Share Splits
Primarily the splits announced after a long run-up in the share price of the company. The main reason is to reduce the share price so that it is affordable for retail investors and thereby increase the investor base. This results in a renewal of investor interest of the company, which has a positive effect on the share price in the short term. For example, the Yes Bank stock had risen by about 29% since the share splits announced in July 2017 till the actual split in September 2017.
Also, it enhances the liquidity in the market as the number of shares is increased—high liquidity results in an efficient market with the low bid-ask spread.
Typical reasons for reverse splits would increase the number of share prices so as to maintain minimum share price as per listing criteria of some of the global stock markets like the New York Stock Exchange. It requires that a stock should be trading for at least $1 a share.
Significance of Share Splits for Investors
- In the case of forward splits, shares are now more affordable to investors. Those who are already invested do not benefit apart from an increase in the number of shares; however, since the price of share also decreases, the overall value for them remains the same.
- Future Earning per share (EPS) may reduce as numbers of shares are increasing. However, for the existing investor, there may not be any impact as his existing numbers of shares are also increasing.
- For a Share split of a blue-chip company, there is a positive perception about further growth of the stock price to pre-split levels during the growth phase of the company.
- Share splits are tax neutral. There is no flow of money during share splits; hence there are no tax implications due to this.
- In the case of reverse share splits, investors need to judge the reason for the same. And if the same is for avoiding delisting of stock from the exchange, it may be perceived as negative.
- In the case of forward stock splits, the number of shares increases; hence the ownership base of the company increases. The shares can now be owned by a wide range of investors.
- Liquidity of the stock increases, thereby increasing the market efficiency of the stock.
- There is no change in the Authorised and Issued capital of the company as it remains the same.
- In the case of reverse share splits, the company can sideline penny stock traders as the price of the share increases.
Stock Splits vs. Bonus issue.
- The bonus issue is similar to forward splits in a way that share price decreases and the number of shares increase in both cases.
- In case of a bonus issue, the company gives additional shares to its shareholders from its free reserves instead of issuing dividends. However, in case of a share split, there is no such fresh issue, it is just manipulation of the already issued capital.
- From an accounting perspective, in case of a bonus issue, as shown above, the company issues fresh shares at the same face value and transfers free reserve capital to issued share capital. In the case of share splits, free reserves and issued capital remain the same.
- Among bonus issue and stock splits, bonus issue may be perceived as more positive as the company is issuing more shares to shareholders from its free reserves. This can be perceived as signaling from management to investors that they are confident of more growth in the future.
A stock splits a change (increase or decrease) in a number of outstanding shares of a company by proportionately changing (decreasing or increasing) the stock price so that overall Market Capitalisation remains the same.
Stock Splits Video
This article has been a guide to Stock Splits. Here we discuss what are 2 for 1, 3 for 1, and 3 for 2 Share Splits along with practical examples. Also, we discuss share split reasons with respect and its significance to investors and the company. You may also have a look at the following articles on Corporate Finance –