What is share splits? How can companies, shareholders and investors benefit from share split?

High priced blue chip stocks become more ‘affordable’ thanks to the share split.

What is stock split and what does it mean for investorsshareholders

There seems to be a new-found love for stock split – or sub-division of shares – among Indian companies of late. Consider this, 48 companies went in for stock split in India over the 10 months of this year, leading up to October, with IRCTC (Indian Railway Catering and Tourism Corp.) being among the new additions.

October alone saw 18 firms announcing stock splits, compared to 11 in the two preceding months combined, the Mint newspaper reported, quoting BSE data. So, what is a stock split and why do companies decide to take such a step?

What exactly is a share split?

A company opts for a share split (also know as stock split) when it wants to make its shares more affordable to small investors. This is achieved by increasing the number of outstanding shares, without actually issuing new ones. So the company simply splits each share into two or more shares. 

This split is commonly in the ratio of two-for-one (2:1), or three-for-one (3:1), depending on the company. Sometimes, it can even be five-for-one (5:1). Depending on the split ratio, the shareholder gets two/three/five split shares of the same value, which together amount to the value of the stock before the split.

Because the original price of the share is constant, the company’s market capitalisation remains unaffected, even though the number of shares has increased thanks to the split. So, if there were 10,000 outstanding shares to begin with, the stock split will result in this swelling to 20,000/30,000/50,000 split shares, with the market cap remaining unchanged.

Why would a company want to split its stock?

One of the most common reasons why companies split their stock is to increase liquidity – that is, make it easier for its shares to be bought and sold. Sometimes, the price of a share may be deemed too high by investors (even if the company’s fundamentals and the market conditions justify it), and this can deter people from participating in trading in that stock.

This hesitancy can be removed if the company reduces the share price via stock split, thereby not only making it cheaper but also making more shares available for trading.

Does share split erode shareholder wealth?

A stock split does not dilute the value of the existing shares – that happens only when new shares are issued. In the latter case, the total market capitalisation of the company may increase, but the existing shareholder’s wealth is reduced.

However, as stated earlier, in the case of a stock split, there is no change in market capitalisation. This means there is no change in shareholder wealth; it neither rises nor falls.

Are there any benefits of a share split for investors?

A stock split makes trading transactions easier, as the stock is more liquid because it now appears to be cheaper. Blue chip company shares, which otherwise would have been very expensive, now become more easily accessible. This pushes up demand for the same from small and retail investors, which helps sellers.

Stock prices also tend to appreciate after a stock split, which augments shareholders’ wealth. However, it can also backfire, as was the case with the Asian Paint stock in 2013; the share price fell from Rs 524 to Rs 376 in a matter of months.

What are the tax implications of share split?

Tax liability does not increase as there is no increase in overall share value. 

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