How do the Stock Split and Stock Merge work?

Learn in detail all that you wanted to know regarding stock splits and stock merge.

How do the Stock Split and Stock Merge work?

One fine day, Mr Sharma logged in to the dashboard provided by his stockbroker. Mr Sharma was surprised to see that the number of shares he was holding in ABC Corporation had doubled and the effective share price was reduced by half. He wanted to identify the reason for this, and he found out that his investment had been influenced by stock split corporate action. This convinced him that nothing fishy had happened to his investment and trading accounts.  

This piece will help you learn the following aspects of stock split and stock merge corporate actions: 

  • What is stock split?
  • Why companies choose to go for a stock split option?
  • How does stock split impact the value of a company?
  • How does stock split, benefit investors?
  • What is reverse stock split or stock merge?
  • Why companies go for a stock merge option?
  • How does stock merge impact the value of a company?
  • How does stock merge benefit investors?

What is stock split? 

A stock split is a corporate action where the price of the stock is adjusted in such a manner that it doesn’t change the market capitalisation. However, the price of the stock gets significantly reduced. For example, before stock split, let's say that the price of a stock is, Rs 10,000 per share with a face value of Rs 10 per share. If the stock split is carried out with a ratio of 1:10 then after the split, the effective price would become Rs 1000 per share with a face value of Rs 1 per share. Also, the number of shares would be multiplied by 10.

Why companies go for a stock split option?

If the price of a stock is too high and the buyer doesn’t have the money to buy a single stock then the transaction can’t go through at all. Therefore the liquidity in the stock would go down on the exchanges. To make the transaction smooth, easy and frequent between investors, companies go for a stock split corporate action. So in simple words, stock split increases the affordability for investors. 

Related: 6 Practical strategies to help reduce investment risk

How does stock split impact the value of a company?

A stock split does not impact the value of a company as there is no change in the market capitalisation. This is because stock split changes the face value of the stock in a ratio which is exactly in line with the reduction of stock price and the number of stocks increases by the same ratio. For example, if there is a stock split in the ratio of 1:10 then the face value will be reduced by a multiple of 10 and the number of stocks which anyone could hold will increase by a multiple of 10.

How does stock split, benefit investors?

Stock split generally increases the liquidity in the stock. This way, investors would be able to sell their equity without any hassle and monetary loss. 

What is reverse stock split or stock merge?

Stock merge is the opposite of stock split. In stock merge the price of the stock increases by the same multiple by which the number of previously issued stocks decreases. For example, if stock merge is carried out in 1:10 ratio, then the face value will increase by a multiple of 10 and the price of the stock will increase by a multiple of 10. The total number of issued shares will also be reduced by the same multiple. So if there is a stock merge carried out on a stock having a price of Rs 20 with the face value of Rs 1, then the effective price post stock merge will be Rs 200 with the face value of Rs 10 and the total issued shares would reduce by 10.

Why companies go for a stock merge option?

Companies usually go for a stock merge option to improve the image of the stocks in the eyes of potential investors so that there is always enough liquidity in the stocks. Usually, a stock merge is carried out on low-value stocks so that investors don’t treat the stock as a penny stock.

Related: Understand the risk associated with mid-cap stocks

How does stock merge impact the value of a company?

Stock merge does not impact the value of a company as there is no change in the market capitalisation. This is so because stock merge changes the face value of the stock in the ratio, which is exactly in line with the increase in stock price. And the number of outstanding stocks decreases by the same multiple.

How does stock merge benefit investors?

Stock merge generally increases the liquidity in the stock; thereby allowing the investors to sell their equity without any hassle and monetary loss. 

Have a look at the important things to know before investing in the stock market to understand the associated risks and benefits better.