A stock split is a corporate action in which a company's existing shares are divided into multiple shares. For example, in a 10-to-1 split, each stockholder receives 9 additional shares for each share he holds or you can multiply the number of shares he has now by 10 in order to find out the total amount of shares he will have after the split.
Unlike an issuance of new shares, a stock split does not dilute the ownership interests of existing shareholders.
If the company pays a dividend, your dividends paid per share will also fall proportionately.
Reasons for Stock Splits
Market Psychology: As the price of a stock gets higher and higher, some investors may feel the price is too high for them to buy, or small investors may feel it is unaffordable. Splitting the stock brings the share price down to a more "attractive" level. The effect here is purely psychological. The actual value of the stock doesn't change one bit, but the lower stock price may affect the way the stock is perceived and therefore entice new investors. Though Buffett’s Berkshire Hathaway has been known to be not in favour of splits with a single share now trading at $120,280
Increase A Stock's Liquidity: There are more buyers and sellers for 10 shares at Kshs. 10 than for 1 share at Kshs. 100. Liquidity increases with the stock's number of outstanding shares.
By splitting shares, a lower bid/ask spread is often achieved, thereby increasing liquidity. Splitting the stock also gives existing shareholders the feeling that they suddenly have more shares than they did before, and of course, if the price rises, they have more stock to trade.
Stock splits have absolutely no effect on the net worth of a company. The market capitalization of the company is not altered and therefore no dilution occurs.
Example
FGH Company has 1000 shares priced at Kshs. 100 per share. The market capitalization is 1000 × 100 = Kshs. 100,000. The company splits its shares 2-to-1. There are now 2000 shares of stock and each shareholder holds twice as many shares. The price of each share is adjusted to Kshs. 50. The market capitalization is 2000 × 50 = Kshs. 100,000, the same as before the split.
A split therefore doesn’t change any of the business fundamentals. In the end, whether you have a Kshs. 1000 note or two Kshs. 500 notes, the money that you have is the same.
Split adjusted share price
If a company has undergone stock splits comparing historical stock prices to those of the present day would not accurately reflect performance. All the closing prices before the split will be taken and divided by the split ratio. If a stock is trading at Kshs. 64 and it splits 4-to-1, the after-split price will be Kshs. 16
Reverse Split
This procedure is typically used by companies with low share prices that would like to increase these prices to either gain more respectability in the market or to prevent the company from being delisted.
For example, in a reverse 10-to-1 split, 40 billion outstanding shares at Kshs. 5 each would now become 4 billion shares outstanding at Kshs. 50 per share. In both cases, the company is worth Kshs. 200 billion. For every ten shares you own, you get one share.
No comments:
Post a Comment