For someone who is 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 may have tumbled significantly, even if they are one of the best in the market. 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 are 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 the Stock Split?
Through stock split, a company increases the number of its shares, which in turn helps in boosting the liquidity of the stock. The main aim of doing this is to reduce the price of their shares and attract more investors. This is a common corporate action that a company may take if the prices of its stocks have soared and made them too expensive for people to buy. 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 2 pencils, just shorter.
Why do companies split stocks?
A stock split modifies the face value of a company’s stock. Let’s see this example -- suppose Company A announces a 1:10 stock split. So, a stock that has a face value of Rs 100 would be divided into 10 shares, where each stock would now have a value of Rs 10. It should be noted here that the value of the investor’s holding would remain the same at Rs 100. The split thus helps the company make its stocks more affordable, as after a stock split, the price of the stock will fall.
Most investors would be more comfortable buying 10 shares of Rs 10 each, rather than just 1 share for Rs 100. So, while the number of shares increases in stock, their value remains the same compared to the pre-split amount. It is because of this that a stock split is said to be a cosmetic phenomenon, as it does not imply any change in the company’s share capital.
How can a stock split be advantageous 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 stocks that are cheaper is always easier.
- The splitting of 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 in reducing the risk as the option premium are reduced.
Conclusion
By dividing the existing shares into multiple new shares, the company reduces its stock prices. The company can thus get dual benefits, the first being making stocks more accessible to new investors and the second being drawing more investors with higher liquidity.
As per reports, Sebi, Securities and Exchange Board of India is proposing to introduce newer and tighter rules and norms regarding the timeframe allowed for the allotment of split shares.