As an investor, you most probably have heard the term “stock split”,
especially if you’re investing in a publicly traded
company.
Let us give you an exact definition of what a
stock split is and why it is practiced by companies.
What is a Stock Split?
A stock split is also knows as a forward stock split. It’s called
scrip issue, bonus issue, capitalization issue, or free issue in the UK.
When stock split happens, a company’s board of directors comes
into a unanimous or majority decision to increase the number of outstanding shares , through the method of
issuing more shares to current shareholders. It divides its existing shares
into multiple shares in order to boost the liquidity of the shares.
Doing a stock split can prove to be a good strategy, but it does not
directly increase the value of the shares in question. It basically helps
change the company’s stock price but not the company’s total market value.
Why companies like doing Stock Splits
Every company can have different reasons for doing stock
splits.
During situations where in a company’s stock price rises,
this is usually perceived as something good. But this also has a downside. For instance,
a stock that has gone up in price too much will make it hard for investors to
buy any more.
This is when stock splits come in. When companies are faced
with the sort of situations stated above, they can then resort to the method of
splitting individual shares of stock to help lower the price of each stock.
Lower priced stocks that have recently been doing well have
a higher probability of attracting more investors without the actual problem of
taking a financial hit.
Liquidity also plays a role in causing stock splits. A stock’s
liquidity also helps in attracting potential investors. This is because if a
company’s price per share is too high, buying the stock will be a riskier
prospect since it will be harder to sell shares that costs more. However, if
the opposite happens and the price of a share goes down, it will be easier to liquefy.
