Definition of 'Stock Split'
This is when a company's shares are divided (split) into multiple shares. 2-for-1 splits are most common where 2 new shares are issued for each existing share however any multiple is possible such as a 10-for-1 issue.
A stock split is the opposite of a reverse stock split.
Even though there are more shares after the split the total market value of the company remains unchanged. After a 2-for-1 split, a company that had issued 10,000,000 shares that were previous valued at $10 each would now have 20,000,000 shares in issued valued at $5. Thus the company's market capitalization of $100 million would remain unchanged.
No real value has been added because of the split although the common theory is that because the shares are now less expensive they will become attractive to a broader audience of market traders which will in turn increase their value. Traders who were previously unable to buy round lots of this company's stock may now be able to.
Stock Split is primarily an American term and in the London Stock Market it is more commonly known as a scrip issue, bonus issue, capitalization issue or free issue.
Why Split the Stock?
A company might have several reasons for splitting their stock. Some of the more common reasons include:
- Increased Accessibility - Most investors lack the ability to buy higher-priced stocks and still maintain reasonable balance in their position sizes.
- Increased Liquidity - Investors may need to sell stock for liquidity reasons. The sale of one high-priced share may generate more cash than they really need and not be tax efficient. This is especially true of stocks priced above $1,000 per share.
- Listing Requirements - If a company's share price falls below a certain level, the primary exchange could delist the stock. A firm might do a reverse stock split to raise the price per share above the exchange required level.
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