What is a share split
A share split is a corporate action that increases the number of shares outstanding by dividing them. An increase in the number of shares leads to a decrease in their price. At the same time, the market capitalization of the company remains the same. For example, in a 2-for-1 split, a shareholder who owned 100 shares now has 200 shares, but the value of the shares is halved. Two hundred shares now equals one hundred shares before the split.
Lets say stock A is trading at $40 and has 10 million shares in issue, giving it a market capitalization of $400 million ($40 * 10 million shares). The company decides to implement a 2-to-1 split. Shareholders who owned shares now have twice as many shares. But, it is worth paying attention to the fact that the capitalization of the company remained unchanged. Since now 20 million shares are worth $20 each and the total capitalization of the company has remained the same - $400 million. The true value of the company has not changed.
The most common splits are 2-to-1, 3-to-2 and 3-to-1. The easiest way to determine the new stock price is to multiply the new price by a factor. If the split is 2-to-1, then we multiply the price by one half (1/2). If the split is 3-to-2, then we multiply the price by two-thirds.
In addition, there is also a reverse stock split. So lets say a 1-to-10 reverse split means that instead of the 10 shares you own, you get 1.
Whats the point of a stock split
There are several reasons why companies do stock splits.
The first reason is psychological. As the share price gets higher and higher, some investors may feel that the price is too high for them to buy or invest. The split is accompanied by a strong decline in the share price. This effect is purely psychological. The actual value of the shares does not change, but the lower price is perceived by investors as more attractive. The split also gives a positive feeling to the shareholders, as they receive an additional number of shares.
Another, more logical reason is that stock splits provide increased liquidity. Liquidity increases with the number of shares outstanding.
Share split, benefits for investors
There is a lot of debate about whether a stock split is an advantage or a disadvantage for an investor. One side says that a stock split is a good buy indicator as the price of the stock has been rising for a long time. But, on the other hand, a stock split has no effect on the fundamental value of the stock, and therefore does not represent any real benefit for investors.
One of the downsides of stock splits is the increased commission. Since the investor owns more shares than before the split, he is forced to pay more commissions on buying or selling shares. Since the commission is calculated from more shares.
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