How does stock splits work

Measure content performance. Develop and improve products. List of Partners vendors. Would you accept the offer and make the trade? This might sound like a pointless question because most people don't get excited over a proposition like this.

After all, you still end up with the same amount of money. There are cases that present similar situations for people in the investment industry— stock splits. But how exactly do they work and, more importantly, are they worth all the excitement?

In this article, we explore stock splits, why they're done, and what it means to the investor. A stock split is a corporate action by a company's board of directors that increases the number of outstanding shares. This is done by dividing each share into multiple ones—diminishing its stock price. A stock split, though, does nothing to the company's market capitalization. So with a 2-for-1 stock split, each stockholder receives an additional share for each share held, but the value of each share is reduced by half.

This means two shares now equal the original value of one share before the split. The company then implements a 2-for-1 stock split. For each share shareholders currently own, they receive another share. So the true value of the company hasn't changed at all. Stock splits can take many different forms. The most common stock splits are 2-for-1, 3-for-2 and 3-for An easy way to determine the new stock price is to divide the previous stock price by the split ratio. Reverse stock splits are usually implemented because a company's share price loses significant value.

Companies can also implement a reverse stock split. A 1-for split means that for every 10 shares you own, you get one share. Below, we illustrate exactly what effect a split has on the number of shares, share price , and the market cap of the company doing the split.

There are several reasons companies consider carrying out a stock split. The first reason is psychology. As the price of a stock gets higher and higher, some investors may feel the price is too high for them to buy, while small investors may feel it is unaffordable. Splitting the stock brings the share price down to a more attractive level.

While the actual value of the stock doesn't change one bit, the lower stock price may affect the way the stock is perceived, enticing new investors. 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.

Another reason, and arguably a more logical one, is to increase a stock's liquidity. Contributor, Editor. Editorial Note: Forbes Advisor may earn a commission on sales made from partner links on this page, but that doesn't affect our editors' opinions or evaluations.

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Performance information may have changed since the time of publication. When a stock split of 2 for 1 happens, you as a stockholder will have two shares for every one share you own, without having to incur any extra cost.

This does not mean that the value of your holding has increased but it does make it easier for you to carry out your trading transactions. It is particularly beneficial for retail investors who can acquire a large number of blue chip company shares which otherwise would have been very expensive.

In most cases, it is seen that a stock split tends to result in the appreciation of the stock price. This is because as the stock now appears to be cheaper, there is a higher demand for it from small and retail investors which leads to a rise in the price.

On a psychological level too it creates a positive approach towards investing in such companies as the stock price that earlier seemed very high becomes available at a good price. Another step companies take with regards to stocks is the reverse stock split. In this instance, the company reduces the total number of outstanding shares by a multiple and thereby increases the share price of the stock by that very multiple.

The market capitalization of the company remains the same with the changes in the value of the shares. If you owned 10 shares of INR each and the company decided to have a reverse stock split of one for two, you will end up with 5 shares of INR per share. You end up with two notes instead of one but the value remains the same. One of the prime reasons for a reverse stock split is for the company to increase the price of its shares. As an investor you will not face any increased liability or reduction in your taxation liability owing to either stock splits or stock merge; this is because at the split or the change thereafter does not change the value of your overall holding.

Investing in shares subjects you to market risk and therefore one must take financial counsel before doing so.