A stock split is a corporate action in which a company divides its existing shares into multiple shares. The primary goal of a stock split is to increase the number of shares outstanding while simultaneously reducing the price per share. Although the overall market capitalization of the company remains the same, the split can have various implications for investors and the stock’s liquidity.

Here’s a detailed explanation of how a stock split works:

1. Motivation:

Companies typically undertake stock splits for several reasons, including making shares more affordable for investors, increasing liquidity, and attracting more retail investors. A high share price might deter smaller investors from buying the stock, so a split can make the shares more accessible.

2. Ratio:

The most common type of stock split involves a specific ratio, such as 2-for-1, 3-for-1, or 4-for-1. In a 2-for-1 stock split, each shareholder receives two shares for every share held before the split. The total market value of the shares remains the same, but the number of shares doubles, and the stock price is halved.

3. Impact on Share Price:

Before the split, the stock’s price may be relatively high, and after the split, the price per share will be reduced proportionally. For example, if a stock is trading at Rs. 100 per share and undergoes a 2-for-1 split, the new price per share will be Rs. 50.

4. Impact on Market Capitalization:

While the number of shares outstanding increases, the overall market capitalization (total market value of all outstanding shares) of the company remains constant. Market cap is calculated by multiplying the number of shares by the stock price, so even though the stock price decreases, the increased number of shares compensates for it.

5. Shareholder Equity:

From the perspective of shareholders, the value of their investment does not change due to a stock split. If an investor owns 100 shares with a total value of Rs. 10,000 before a 2-for-1 split, after the split, they will own 200 shares, each valued at Rs. 50, maintaining the total value at Rs. 10,000.

6. Liquidity and Accessibility:

Lowering the stock price through a split may attract more investors, including retail investors, and improve liquidity. This increased liquidity can be beneficial for both existing and new shareholders.

7. Psychological Impact:

Stock splits can have a psychological impact on investors. Some investors may perceive a lower-priced stock as more affordable, even though the economic value of their investment remains unchanged.

8. Reverse Stock Split:

In contrast to a regular stock split, a reverse stock split involves reducing the number of outstanding shares, typically in the form of a ratio like 1-for-2 or 1-for-10. This is often done to increase the stock price, making it more attractive to institutional investors or to meet listing requirements on a stock exchange.

In summary, a stock split is a strategic move by a company to adjust its share price and make its stock more accessible to a broader range of investors. While the economic value of the investment remains the same for shareholders, the split can impact the stock’s liquidity, appeal, and market perception.