Stock Split Definition: Everything You Need to Know
The stock split definition is when a corporate action in a business causes the current shares to divide into multiple shares so it increases the liquidity of those shares. 3 min read
The stock split definition is when a corporate action in a business causes the current shares to divide into multiple shares so it increases the liquidity of those shares. While the number of shares will increase, the overall dollar value of them stays the same when compared to the pre-split amounts. The split doesn't actually add real value. The most common splits are the 3 for 1 or 2 for 1 ratios. This means the stockholder will have three shares and two shares respectively for every one share they had before the stock split.
What Is a Stock Split?
A stock split is also known as a bonus issue, free issue, script issue, or capitalization issue in the United Kingdom. When this goes into place, the prices of the shares automatically adjust in the markets. The board of directors in a company is in charge of splitting the stock any way they want to. While 2 for 1 and 3 for 1 is common, they can also do 10 for 1 or 100 for 1 and so on. A 10 for 1 stock split means that for each share an investor has, there will now be ten.
This overall value of the company will still be the same due to market capitalization. This can be figured out by multiplying the total shares by the price each share is worth. As an example, if a company has 20 million shares total that are trading for $100 each, the market cap will be two billion dollars. If the board of directors splits the stock 2 for 1, the number of shares will grow to 40 million. However, the price of the shares will be cut in half to $50 each, so the overall value is still two billion dollars.
All companies that are publicly traded have a certain number of outstanding shares. The board of directors makes decisions on a stock split to increase the amount of shares that are outstanding by giving additional shares to the current shareholders. In the case of a 2 for 1 stock split, an extra share is given for every share a stockholder currently owns. If there were 10 million shares before the split happened, they will now have 20 million shares after the split occurs.
Why Do Stocks Split?
Stock splits are often done when companies see their share price go up to levels that are higher than price levels of other companies in their sector or too high. The main motive is to make their shares seem like they're affordable to smaller investors even if the overall value of the company has stayed the same. In turn, liquidity in the stock is increased. Share price increases can occur after a decrease right after the stock split. Many smaller investors will, therefore, perceive the stock as more affordable and purchase it, which boosts demand and increases the prices.
A stock split also shows the market that the share price of the company is increasing and people assume they'll see continued growth as time goes on. One example is as follows:
- Apple split their shares 7 to 1 so it was more accessible.
- Each share cost $645.57 before the split.
- That went up to $92.70 per share after the split.
- Shareholders got six extra shares for every share they owned.
- Apple's shares went from 861 million to 6 billion, but the market cap stayed the same at $556 billion.
- The price per share increased to $95.05 the day after the split to show the now increased demand.
More shares can cause an increased stock liquidity, which narrows the bid-ask spread and facilitates trading. It makes it easier for sellers and buyers to trade stocks. There's more flexibility with liquidity so investors can sell or buy shares in the business without making too large of an effect on the share price. A split shouldn't have an effect on the stock's price, but it usually renews the interest of investors, resulting in a positive effect on the price of the stock. Stock splits are good ways for investors to obtain more shares in a company.
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