Stock splits on the stock exchange and how stock prices react to them
If you've analyzed the stock prices of leading companies, you've probably wondered why there was a sharp drop in the value of securities at a certain point in time?
However, no one reported the company's collapse, even though its share price had fallen several times. This was all due to a stock split, or, as this process is also known, a securities split.
A stock split (or stock split) is a process in which a company divides its existing shares into several new shares, while the company's overall market value remains unchanged.
This is a popular practice in stock markets used by companies to make their shares more accessible to a wider range of investors.
How does a stock split work?
When a company announces a stock split, it may divide one share into two or more new shares. Dividing one share into two new shares is called a 2-for-1 split, meaning each existing share becomes two new shares.
As a result, investors hold twice as many shares, but the value of each one decreases proportionally. However, the total value of their portfolio remains the same.
Example: Let's say you owned one share of a company's stock, which is worth $100. After a 2:1 split, you'll now own two shares, each worth $50. This leaves your total stock value at $100.
Reasons for a stock split
Companies split their stock for a variety of reasons. The main ones include:
Share Price Decrease : When the price of a single share becomes too high, it can discourage new investors. A stock split lowers the price, making it more attractive to buy.
Increased Liquidity : A stock price reduction due to a stock split can attract more market participants. This increases trading activity and liquidity.
Attracting Small Investors : Highly priced stocks may be inaccessible to small investors. A stock split makes shares more accessible to people with less capital to invest.
Types of stock splits
A regular split : For example, 2:1, 3:1, or even 10:1. In a 3:1 split, a shareholder receives three new shares for every old one. Thus, the total number of shares increases threefold.
Reverse split : This is the opposite of a regular split, where several shares are combined into one. This is done to increase the share price, especially if it is too low. A reverse split can be done in a ratio, for example, 1:5, meaning that every five shares are combined into one.
Examples of famous stock splits
Apple : One of the most famous stock splits took place in 2020, when Apple split its shares 4:1. This lowered the price per share, making it attractive to investors.
Tesla : In 2022, Tesla also conducted a 3:1 split, reducing the price of its shares by a third.
Typically, after a stock split, the price of the underlying asset begins to rise, driven by psychological factors. Investors remember that one share used to cost $1,000, but now it's only $200, so they buy the security.
A stock split is a useful tool companies use to manage their shareholder base and maintain market appeal. While it doesn't change the company's overall market value, it makes the shares more accessible and liquid , which can positively impact trading activity and attract new investors.
