A stock split involves issuing new shares without receiving additional cash. In a stock split, each share is split into a more significant number – for example, in a 2-for-1 split, each original share results in 2 shares after the split. After a stock split, a company’s value is unchanged. However, it reduces the stock price. Also, the par value of the share is reduced.
A share split is achieved by dividing the existing share capital into a more significant number of shares with a lower nominal value per share. Splitting the nominal value of shares in this way will affect the market price. Psychologically, investors may view the share more favorably if the price has been brought down in this way.
One advantage of a stock split is that it reduces the market price, making it more affordable to potential investors. When the price for a share of stock gets too high, some investors may not want to purchase any shares because they cannot purchase a significant number of shares at one time or view the purchase as a substantial risk to their wealth. Therefore, after a stock split, the shares become more affordable.
Example: Stock Split
A corporation has outstanding 500,000, Rs 12 par value shares, and the market price is Rs 60. The management of the company decides to enact a 3-for-1 stock split. After the stock split, the market value of each share will be only Rs 20, but there will be 1.5 Million shares outstanding. Also, the par value of the shares will be Rs 4 each. As a result of this split, each shareholder owns the same percentage of the company and the same market value of shares as before the split. It is just that they now own 3 times as many shares, each of which is worth 1/3 as much.
Consider the case of a company that has issued 1 million ordinary shares at par value @ Rs 10/- per share but wishes now to reduce the price of its shares by replacing that issue with a new issue of 2 million shares at a nominal value of Rs 5. The results can be seen in the simplified balance sheet section as follows. In effect, the company is engaging in a 2:1 stock split. Before the new issue, the shares are trading at Rs 20/- each.
| Share Split | |||
| Impact on the Account (All Amounts in Rs’ 000) | |||
| Before | Issue | After | |
| Net assets | 20,000 | 20,000 | |
| Share capital | |||
| Ordinary shares 1 M @ Rs 10/- | 10,000 | (10,000) | |
| Ordinary shares 2 M @ Rs 5/- | 10,000 | 10,000 | |
| Share premium | 5,000 | 5,000 | |
| Profit and Loss | 5,000 | 5,000 | |
| Total | 20,000 | 0 | 20,000 |
| Impact on the Share Price | |||
| Shares(In Millions) | Market Price(Rs) | Value(Rs, In Million) | |
| Before | 1 | 3.00 | 3 |
| Share split | 1 | ||
| After | 2 | 1.50 | 3 |
(1 Million = 1,000,000)
Consolidation or Reverse Split
A reverse stock split, or consolidation, reduces the number of shares and increases the share price proportionately. For example, if you own 10,000 shares of a company and it declares a one-for-ten reverse split, you will own a total of 1,000 shares after the split. A reverse stock split does not affect the value of what shareholders own.
Companies often split their stock when they believe the price of their stock is too low to attract investors to buy their stock. In addition, some reverse stock splits cause small shareholders to be cashed out, so they no longer own the company’s shares.
A company’s board of directors may declare a reverse stock split without shareholder approval. However, the activity of reverse split is carried out according to the directives of the capital market regulator.
In the table below, a company has decided to issue 500,000 new shares with a nominal value of Rs 20/- each to replace its one million existing shares with a nominal value of Rs 10/- each. The reverse split is, in effect, a 1-for-2 split. The company’s share capital remains the same at Rs 10 Million, but the stock price would have effectively doubled as there are now only half the shares outstanding compared to those before the reverse split.
|
Reverse Split |
|||
|
Impact on the Account (All Amounts in Rs’ 000) |
|||
| Before | Issue | After | |
| Net assets | 20,000 | 20,000 | |
| Share capital | |||
| Ordinary shares 1 M @ Rs 10/- | 10,000 | (10,000) | |
| Ordinary shares 0.5 M @ Rs 20/- | 10,000 | 10,000 | |
| Share premium | 5,000 | 5,000 | |
| Profit and Loss | 5,000 | 5,000 | |
| Total | 20,000 | 0 | 20,000 |
|
Impact on the Share Price |
|||
| Shares
(In Millions) |
Market Price
(Rs) |
Value
(Rs, In Million) |
|
| Before | 1 | 3.00 | 3 |
| Share split | (0.5) | ||
| After | 0.5 | 6.00 | 3 |
(1 Million = 1,000,000)
Conclusion: Corporate Actions that affect Market Price of a Share
A stock split is a corporate action in which a company’s shares are divided into multiple new shares. This division is typically done to make the shares more affordable and attractive to potential investors. The value of the shareholders’ investment will remain the same, but each share’s price will change.
On the contrary, a reverse split can be thought of as the opposite of a stock split. A company’s shares are consolidated into fewer new shares in a reverse split. This is typically done when a company’s shares have become too expensive and less attractive to potential investors. Reverse splits are sometimes conducted to meet certain exchanges’ minimum share price requirements.