How does the ratio work?
When companies in the stock market want to have more investors, they tend to go towards a stock split. By doing a stock split, companies lower the price of an individual share, making it more affordable for retail investors. Stock market investors need to be aware of the consequences of a stock split on their existing shares of the company, so let's dive into the details of a stock split and the different terms related to it.
What is the meaning of stock split?
A stock split is a method by which a company issues more shares to its existing shareholders by lower the face value of its shares by a specific ratio. This means that the market capitalisation of the company remains unchanged, and there is an increase in the number of shares with each shareholder. To understand stock split more clearly, you need to understand the meaning of the stock split ratio.
What is a stock split ratio, and how it works?
Simply put, the stock split ratio is the ratio in which a stock splits. These ratios are usually in the form of 2:1 or 3:2, meaning that the company will give two or three shares for a specific number of shares a stock owner has. This results in a decrease in the face value of the stock and its value is split into multiple shares after a stock split. Let's understand the working of the split stock ratio with an example.
For instance, you have 100 shares of a company in your demat account. And each of these shares is valued at Rs 1200. If that company announces a stock split in the ratio 2:1, you will have two shares for each share of the company. This means that you will now have 200 shares of the company, which will be valued at Rs 600.
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When will the final shares reflect in the account after a stock split?
The new sub-divided shares will reflect in the DEMAT account with its ISIN number on the next trading day after the record date set by the company. Let's understand some terms associated with a stock split to understand this process.
- Ex-split date - This is the date from which a company's stock starts trading in the stock market at the new split price.
- Record date - It is on the record date that the company checks the shares of its existing shareholders to confirm their eligibility for a stock split.
How does an investor benefit from a stock split?
There are a few benefits that an investor enjoys after a stock split is announced. These are as follows:
Stocks of the company become affordable:
The stock price of a company's shares increases as it starts making a profit in its business. This inflates its share price to a very high level, making it difficult for retail investors with less to invest in the company. A stock split lowers the face value of each stock of the company, making it easier for retail investors to buy new shares of the company.
Increases liquidity of the stock:
When the liquidity of a company's stock increases in the stock market, it becomes effortless for investors to buy or sell the stocks of that company. This is because when the face value of a stock falls after a split, its demand increases significantly. Liquidity also helps investors rebalance their portfolios easier, as low-price shares are easier to sell in the market.
Why does a company announce a stock split?
A stock split is definitely a good thing for an investor, as they get the stock at a lower price. However, there are some benefits for the company as well. Let's discuss them one by one.
- The liquidity of the share of the company increases in the market, making it accessible to retail investors,
- New investors buy the company's shares, which inflates the share prices and ensures that it trades at a high price.
Companies have used stock splits for years to increase the liquidity of their stocks. It makes it easier for investors to add shares of a fundamentally strong company to their portfolio at a lower price. So next time you come across a stock split announcement, check the stock split ratio to get an estimate of the price of the shares after a stock split.