Companies are always on the lookout to appeal to new investors. If a company believes that its share price is too high and needs to attract new investors, it often issues a stock split. If you’re wondering what a stock split is, we explain its meaning and significance below.
A company can choose the corporate action of subdividing its shares, also known as a stock split, to appeal to prospective shareholders. By reducing the share price, it can attract new investors without changing its market capitalisation. This way, the company can increase the number of shares that are available to purchase and sell on an exchange.
Another important aspect to remember is that while the stock split reduces the share price, it does not impact its current shareholders. This is because the organisation lowers the face value of each share at a certain ratio. By dividing the shares previously issued to the existing shareholders, the number of outstanding shares is increased, but the value of each shareholder’s stake doesn’t change.
The stock split is done in a prescribed ratio. Let us assume that this ratio is 10:1 (or 10-for-1). The 10:1 stock split meaning is fairly intuitive; it implies that for every one share held, shareholders get ten shares (post-split). To better understand this concept, let us look at the table below that highlights the number of shares, split share prices, and the face value of the share pre and post-split for various ratios.
Pre-split | Post-split | |||||||
Stock split | No. of shares held | Share price | Face value | Investment value | No. of shares held | Share price | Face value | Investment value |
2:1 | 10 | 500 | 10 | 5000 | 20 | 250 | 5 | 5000 |
5:1 | 10 | 500 | 10 | 5000 | 50 | 100 | 2 | 5000 |
10:1 | 10 | 500 | 10 | 5000 | 100 | 50 | 1 | 5000 |
As evident from the table, the investment value does not change. You must also remember that in a stock split, the share’s face value is reduced by the ratio of the split.
How does a stock split affect you?
Existing shareholders may not observe any perceptible changes or effects following a stock split. However, this can ease your portfolio management and offer more liquidity, along with more number of shares. On the other hand, if you are a prospective shareholder looking to invest in the company, you can purchase shares at a lower price following the stock split.
You may still wonder why a company would split shares, but there are several reasons why companies choose to subdivide their shares. The main reason is to increase the stock’s liquidity, which increases with its number of outstanding shares. Another reason is more psychological; a stock with a high share price can act as a deterrent. By splitting the stock, the company can reduce the share price to make it more appealing.
Let us take an example. Assume that Apollo Hospital’s share price pre-split was Rs. 5,000. Following a stock split in the ratio of 5:1, the share price would be Rs. 1,000. This makes it more affordable for prospective shareholders to purchase shares in the company, while the current shareholders can easily manage their portfolios.
Additional read: Types of stock trading
Key dates in a stock split
- Record date: The record date is when a company reviews its records to identify shareholders eligible for a stock split.
- Ex-split date: The ex-split date marks when the stock begins trading at the newly adjusted split price.
Existing shareholders will receive sub-divided shares credited with the new ISIN on the trading day following the record date.
Adjustment of Future & Options contract due to a stock split
Following the stock split, revisions to market lots and strike prices for F&O contracts using the stock as an underlying security will be determined by computing the adjustment factor.
For a stock split of A: B, the adjustment factor is (A/ B). For example, if the stock split ratio is 5:1, the adjustment factor is 5.
- Futures/Strike price: You can find the revised futures/strike price by dividing the old futures/strike price with the adjustment factor.
- Market lot: Similarly, you can determine the revised market lot by multiplying the old market lot with the adjustment factor.
To help you understand this better, let us take the example of TATA Steel, which opted for a stock split in the ratio of 10:1 in July 2022.
Before adjustment:
Instrument | Security symbol | Expiry date | Strike price (Rs.) | Option type | Long Position | Short Position |
OPTSTK | TATASTEEL | 28/Jul/2022 | 1300 | PE | 425 | |
OPTSTK | TATASTEEL | 28/Jul/2022 | 1300 | CE | 425 |
After adjustment:
Instrument | Security symbol | Expiry date | Strike price (Rs.) | Option type | Long Position | Short Position |
OPTSTK | TATASTEEL | 28/Jul/2022 | 130 | PE | 4250 | |
OPTSTK | TATASTEEL | 28/Jul/2022 | 130 | CE | 4250 |
Keep in mind that the investment or contract value of a futures or options contract remains unchanged after adjustment for a stock split.
What is a reverse stock split?
While you now understand what a stock split is in the share market, you must also know about a reverse stock split. A company can also reduce its outstanding shares by increasing the share’s face value without reducing the market capitalisation. Similar to a stock split, the shareholder’s investment value remains unchanged by a reverse stock split.
Let us assume you hold 100 shares in a certain company (let’s call it ABC) at a share price of Rs. 10. Your total investment value in the company is 100*10 = Rs. 1,000. If the company opts for a reverse stock split in a 1:2 ratio, you will now hold 100/2 = 50 shares. However, your total investment value remains Rs. 1,000.
Thus, a stock split allows prospective investors to buy shares in the company and provides greater flexibility to the current shareholders, with more liquidity and ease of portfolio management. If you are looking to invest in a certain stock and it goes for a split, you can easily buy it at a lower price.
