- Stock splits or share splits are the phenomenon of distributing one share unit into multiple share units.
- It's done to minimize volatility, over-pricing, and maximize a business' exposure to investors.
- The company that splits the share can decide the ratio and the frequency of the split.
- A split would directly impact the quantity of the shares and the face value of the share. However, the post-split share’s market price depends on the supply and demand of that equity too.
- Big companies like Facebook and Netflix too have gone for share splits. Read on to know more!
The share market can be quite Pandora's box to the unwilling and undoubting. If you are new to the market, be it as an investor or some business getting listed, you need to understand it. Some make a profit from the market fluctuation, while others lose in heaps. To make sure your business gets the most of the market, you may need to introduce split shares. Not only do investors need to know about shares and their splits, but even companies that aspire to get listed on the stock exchange should also be prepared well in time. It is, after all, the company’s decision to split a share.
However, why does a company split a share? What happens to the share undergoing the split? How do investors receive it? How does the market receive split stocks? What is the aftermath of the stocks' reputation post-split? And do you need to split stocks?
All these questions will be answered in this handy guide, so just sit close and read! Moreover, in this article, we will tell you what exactly is a 2 for 1 stock split.
To understand what is a 2 for 1 stock split, we need to know what is a stock split first.
So, let us jump right onto this.
What is a Stock Split?
A stock split is when a share gets divided into multiple shares; thus, its listed price gets lowered. Many companies do splits to encourage investors to raise more funds. When a share gets split, its face value gets divided in the same proportion as well.
To make it easier, let us consider that a company decides to split its stocks. The price of each share of the company is USD $100, and the company decides to go for a 5:1 stock split. Then this means that if an investor had 20 shares initially, post-split, he would have 20x5 = 100 shares. The share's price will also come down from USD $100 to USD $20 after the split. Please keep in mind that listing prices are determined based on the supply and demand of a share. So, the market value may be higher and lower than what is expected via the ratio. However, the face value or the share’s intrinsic value will become 1/5th of the original price.
Stock splits encourage more secondary market investments. When a share gets too lofty for investors, the equity funds may take a hit. How?
- An expensive market price means more profit booking.
- It also means lesser new investments.
- It will propel the bearish pattern to follow.
- It can cause stagnation in returns for existing investors.
These are certain aspects that prompt a company to pursue share splits. If you are an entrepreneur that is considering a stock split, you should know:
- Lowering the price may systemize the reiteration of investments.
- Since a business requires funds to operate, splitting shares is a lucrative way to raise more equities.
- It does not affect existing investors, and some may even favour this decision.
However, a split does not always have to be public or for all the shares out there. It can happen between co-founders, employees, board of directors, non-preferential shares, and more too. Learn how a co-founder split happens.
What is a 2-for-1 stock split?
Written down as a 2:1 split, this simply implies that for each stock you own, you would have 2 stocks at nearly half the price, after the split. It doubles the number of your stocks. If you previously had 200 shares of the company concerned, then you would bag 400 shares after the splitting. And if the previous price of the share was USD 10, it would become USD 5.
For the company owner, this means that the share’s face value would be halved. Besides, share splits do not cause a change of ownership since each investor gets more shares by the same ratio. For instance, those who had 100 shares, would be having 200; and those with 1,00,000 shares would log 2,00,000 shares. Therefore, their stake in the company remains the same.
However, a share split has more advantages for the business than for the investors. It helps increase the stock's circulation in the market as well. How? Let us assume that before the split, a company had only 10 shares in the market but now, after the 2:1 split, it has 20.
How does a 2-for-1 stock split work
The concept of a 2:1 stock split is simple. A company that issues the share can decide to split it however they like, but the most common ratios for a stock split are 2:1 and 3:1.
How to Calculate the Price of Share Post Split
When you hear a share is to be split, you should assume that its prices will drop and the number of available shares in the equity market, plus your equity holdings, will rise. So, there is a simple mathematical formula to decide on the price of the share post-split.
For Eg - If the split is in the ratio of 5:1 then you have to divide the share’s current price by 5.
Let us say, the share was priced at USD10. Now, post 5:1 split it will become:
10/ (5/1) = USD2
Similarly, if the split ratio is 2:1, the numerator would be the share’s current price or face value, and the denominator would become 2.
How to Calculate the Quantity of Company’s Shares Post Split?
A simple calculation method is to even the ratios: commonly referred to as “Even-ing”. You have to make sure that the numbers on both sides of the ratio sign (:) become equal. In the case of 5:1 stock split, to get 5 on both sides, you have to add 4 to 1. This gap is the number of shares you will get extra after the split.
In ratios like 3:2 or 5:2, one could use the mathematical formulae explained above to get a precise answer. However, in these cases, the gap between the two numbers applies for every two shares. So, you would get one extra share for every two shares in a 3:2 split. And three shares extra for every two shares in a 5:2 split.
Although there are some legalities and paperwork involved in splitting the shares, the companies have the free call to choose the equity ratio. Moreover, a company may decide to split its shares more frequently than other companies. For instance, Facebook, the social media biggie, has a history of share splits.
How many times has Facebook split stocks? Believe it or not, Facebook has undertaken stock split ratios as high as 4:1 in 2006 and 2007. Then, in 2010, Facebook gave another split with a ratio of 5:1. However, these were not the shares listed on exchanges. Before 2012, Facebook was a private limited company and not a listed public entity. In 2016, Facebook’s public shares split by 3:1.
Let us take another big name as an example. How many times has Netflix stock split? Twice, so far! Every time the company’s share price goes above $700, Netflix Board chooses to make it more accessible by splitting.
Netflix further proves why share splits are beneficial for a company. Let us look into more benefits of a share split.
Benefits of Stock Split
During a bullish market, all shares tend on the heavier side. The prices rise, and while this is good news for existing shareholders, it scares potential investors who are new to the market. Moreover, overvaluation is always avoided by investors when they look to put some money in a share. Besides, overvalued shares are exhaustive, vulnerable, and on the "Don't buy under any circumstance" list for most investors.
Helps attract new investors
When a share is priced sensibly and not sensitively, it attracts more prudent and practical investors looking for long-term prospects. When a company splits its stocks, the shares become more accessible and their supply in the market increases as well. Some investors, who may not have been able to buy the shares in the past given the limited liquidity, can also become active players post-split.
Higher liquidity in the exchanges
Let us assume that before a 5:1 split, only 10,00,000 shares of a company were available. It may sound like a huge number, but it is not considering the heap of investors on the lookout. Imagine only 10,00,000 shares of Facebook. So many people would line up for them, but the acute supply will hike the prices acutely too. Thus, by going for a 5:1 split, a business with 10,00,000 shares would now have 50,00,000 offerings. It makes the business far more approachable and investable.
Attain more stability amidst speculation
When a share is overpriced, the market sentiment gets bearish, and the investors fear a crash or a meltdown. While the company may be strong, emotions rule the street. Doing a split helps attain stability and a favourable spectrum.
Limitations of Stock Split
When a company goes for a share split by say, a ratio of 2:1 or 5:1, it floods the market with twice or five times as many shares overnight. In the case of good companies, there will be active seekers who will instantly occupy those shares. However, in the case of younger or average performing companies, this may create more than demanded. When supply is more than demand, it ultimately leads to a drop in price, which can disrupt old investors too.
Attracts casual traders
Let us assume that a company undergoing a share split also happens to be a great company. In that case, the lowered share prices would attract short-term and casual traders looking to make quick money off the split. It means that the business may factor in equity funds that would not be around for the longer utilization.
When a stock attracts traders, it surfaces as equity that is prone to fluctuate quicker. Trading stocks are known to be drastically volatile, uncertain, and not favourable to long-term investors.
Not beneficial if done by a premium brand
Think of Gold! We never see gold lowering its prices to accommodate more providence. The same goes for a quality company with a bankable stock. Irrespective of their price tag, quality investors would still seek these companies.
More Things to Know about stock splits
Just as there are stock splits, we also have reverse splits in the equity market. A reverse split, as the name suggests, is when a firm decides to merge its existing shares. So, if the reverse split is done in the ratio of 1:5, for every five shares you had, you would now only have one share. The price also would be adjusted similarly.
- Do not confuse split shares with bonus shares. Bonus shares would not lead to a lowered face value.
- Although splits are not known to influence share investors, in general, the price of the share would hike after the split.
- Share splits or stock splits may sometimes alter the intrinsic share properties. For instance, after a split, your voting rights or dividend claims may be nullified in some contracts.
However, each split share doesn't have to play out the same.
Learn more with us
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Access more guides in our Knowledge Base for Startups.
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