What is a stock split

October 5, 2009

As you might be knowing certain stock may split, giving stock holders twice as many shares as before. A stock split is a decision by the company's board of directors to increase the number of shares that are outstanding by issuing more shares to current shareholders.
For example, in a 2-for-1 stock split, every shareholder with one stock is given an additional share. As well as at the same time, the value of each share is cut in half.(A stock split is like receiving 2 Ten-dollar bills for a single Twenty-dollar bill.)Thus, although the number of outstanding shares and the stock price change, the market capitalization remains constant.

Why Would a Company Do Stock Splits?
A stock split is usually done by companies that have seen their share price increase to levels that are either too high or are beyond the price levels of similar companies in their sector. The primary motive is to make shares seem more affordable to small investors even though the underlying value of the company has not changed.

A stock split can also result in a stock price increase following the decrease immediately after the split. Since many small investors think the stock is now more affordable and buy the stock, they end up boosting demand and drive up prices.

Stocks can be split by a number of ratios although the most common are 2-for-1, 3-for-2, and 3-for-1. Stocks can also be reverse-split, that is the company decreases the number of outstanding shares so that each stock holder has smaller amount of shares than before. Reverse stock splits are less common, although can be used for several reasons: the first one is the price per share may be so low that it appears as a poor investment; second one is the company may be attempting to stave off possible delistment on the stock exchange; last but one is to push out minority stockholders; lastly as a way to go private.

The bottom line is a stock split is used primarily by companies that have seen their share prices increase substantially and although the number of outstanding shares increases and price per share decreases, the market capitalization (and the value of the company) does not change. As a result, stock splits help make shares more affordable to small investors and provides greater marketability and liquidity in the market.

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