For someone new to investing, keeping an eye on the stock market can be quite daunting. Unpredictable as it can be, you may often start your day with surprises from the market. Sometimes you may see that the stocks that you’ve invested in, even if they are one of the best in the market, may have tumbled significantly. This can come as a shocker, especially if you have not been tracking the company’s corporate development or have missed a company notification.
While seeing a sharp drop in the stock value can be disturbing, sometimes there’s more to it. One reason for a price drop can be a stock split announced by the company. Rather than being a disappointment, the stock split can work in your favor as an investor.
So if you’re wondering why and how the average price has decreased due to the stock split, read on as we discuss the stock split in detail, and see how it can affect you.
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What is a Stock Split?
A stock split is a corporate action that involves increasing the number of shares a company has, which ultimately enhances the liquidity of the stock. The primary objective behind a stock split is to lower the price of individual shares, making them more accessible to investors. This strategy is commonly employed when a company's stock prices have surged, resulting in them being prohibitively expensive for potential buyers.
By implementing a stock split, companies aim to attract a broader range of investors and facilitate greater market participation.
To put it in simple words, a stock split is like breaking a pencil into two pieces. Rather than having one big pencil, you end up having two pencils, just shorter.
Why Do Companies Split Stocks?
A stock split is a mechanism that adjusts the face value of a company's stock. For instance, consider Company A's announcement of a 1:10 stock split. In this scenario, a stock with a face value of Rs. 100 would be divided into 10 shares, each valued at Rs. 10. It is important to note that the total value of the investor's holdings would remain unchanged at Rs. 100.
The purpose of a stock split is to enhance affordability by reducing the stock price. By increasing the number of shares and maintaining their value, a stock split allows investors to purchase multiple shares at a lower price, making it more appealing. Therefore, a stock split is often considered a superficial event, as it does not impact the company's share capital.
How Can a Stock Split Be Beneficial For An Investor?
Let us take a look at the various benefits that you, as an investor, may get from a stock split:
- Most investors wish to invest in big companies but find it difficult to do so, as the stock prices do not suit their budget. Investing in cheaper stocks is always easier.
- Splitting stocks improves liquidity. The price drop brings the stock into a more active trading range.
- Rebalancing the portfolio becomes easy, as low-priced stocks are easier to sell and churn.
- As an investor, a stock split also helps you reduce risk as the option premium is reduced.
The Takeaway
A stock split lowers prices, attracting investors and boosting company profitability. It divides existing shares into multiple new shares to increase accessibility and enhance financial performance.
As per reports, SEBI (the Securities and Exchange Board of India) has proposed to introduce newer and tighter rules and norms regarding the time frame allowed for the allotment of split shares.