Listed companies go through several corporate actions during their regular course of business. These corporate actions include the payment of dividends, issuance of bonus shares, and stock splits. While the distribution of dividends is the most common type of corporate action performed by a company, stock splits are quite uncommon. In this article, we will cover what are stock splits, and also discuss is stock split good or bad.
What Are Stock Splits?
A stock split is a corporate action of increasing the number of shares of the company by reducing the face value of the stock. Companies perform a stock split to increase their liquidity as the price of the shares reduces after the split.
Though the stock split increases the number of shares of the company, the overall market capitalization remains the same as even the price of the shares will be divided as per the ratio of the split.
As mentioned above, the split occurs in a predetermined ratio. For example, if the ratio of the split is 1:3, it means that the shareholders will get 3 shares for every share held by them.
Lets us further understand how the changes in the number of shares, share price, and the face value of the shares occurs before and after the stock split.
Example 1
When the stock split happens in the ratio of 1:5
| No. of shares held | Share Price | Face Value of shares | Value of Investment | |
| Before Split | 10 | 100 | 10 | 1000 |
| After Split | 50 | 20 | 2 | 1000 |
Example 2
When the stock split happens in the ratio of 1:2
| No. of shares held | Share Price | Face Value of shares | Value of Investment | |
| Before Split | 10 | 100 | 10 | 1000 |
| After Split | 20 | 50 | 5 | 1000 |
Note: During a stock split, even the face value of the shares decreases according to the ratio of the split.
Adjustment of the stock split in Futures and options contract
The market lot and the strike price in the futures and options contract will be revised as per the split made in the underlying asset.
- Futures/ Strike Price: The new futures price or strike price (in the case of Options) will be calculated by dividing the old futures/strike price by the split ratio
- Market Lot: The new adjusted market lot is calculated by multiplying the old lot size with the ratio of the split
Let us understand these adjustments with help of an example. Let us assume that the split occurs in the ratio of 1:5
| Instrument | Strike Price (₹) | Lot Size | Premium | |
| Before Adjustment | OPTIONS | 1500 | 100 | 200 |
| After Adjustment | OPTIONS | 300 | 500 | 40 |
The value investment made in a futures or options contract will remain the same after adjustment.
Is Stock Split Good Or Bad?
The answer to this question purely relies on the perspective of the investors as there are both Advantages and Disadvantages to a stock split. Let us now take a look at each of them below.
Advantages Of A Stock Split
The following are the advantages of a stock split:
- Affordability: Individuals tend to stay away from stocks that they feel are expensive for them to buy. A stock split can decrease the price of the shares which will make it affordable and attract more investors.
Example: Let’s take a look at the stock of IRCTC ltd which had a stock split on 27/10/2021 in the ratio of 1:5. Before the split the stock was trading at Rs. 4152 which is considered expensive for general investors.
On the day of the split, each share was divided into 5 shares and the share was trading in the range of Rs.900-930. This made the shares considerably affordable to most investors.
- Liquidity: Stock split divides the number of shares of the company as per the ratio of the split. This increases the number of shares of the company which in turn increases the stock liquidity. Increased liquidity makes it easy for individuals to buy and sell the shares without having a major impact on the share price.
Example: If we consider the same stock as the previous example, we can see that each share got split into 5 shares. So, if the trading volume was 7,49,400 shares before the split, it would increase to 37,47,000 shares after the split.
- Increases Capital: As the stock split reduces the price of the shares, it will attract more investors to the company. This can help the company to increase its capital.
Disadvantages Of A Stock Split
The following are the disadvantages of a stock split:
- Could increase volatility: A may witness increased volatility as more individuals start trading the share after the stock split.
- Stock Splits cost Money: It costs time and money for the company from the announcement through the execution of the stock split. The company might have to hire a bank to plan and execute a stock split that requires a fee. This fee could have been used for other useful resources in the business if there wasn’t a split.
Also Read: What Is A Low Float Stock? – Low Free Float!
In Closing
In this article, we discussed what is a stock split, how a stock split works and we also discussed – is stock split good or bad.
Although the stock split doesn’t affect the fundamental value of the company, they have a significant impact on how investors perceive the price of a particular stock.
Tags: Is Stock Split Good Or Bad, How to Profit From Stock Splits & Buybacks, Is a stock split bad for investors?, Is it a good thing when stocks split?, Do Stocks Go Up After split?, Is it better to buy stock before or after a split?, Are Stock Splits Good or Bad?, Are Stock Splits Bad for Investors?, What is a stock split?, Who benefits from a stock split?, Should I buy before or after a stock split?, Disadvantages of stock split, Do you lose money when a stock splits, What happens when a stock splits 4 to 1