You may come across the term ‘stock split’ when investing in the stock market. It may seem confusing at first, but it is quite simple. It is a corporate action that involves dividing a company’s total shares into a larger number of shares. The total value of your investment doesn’t change, but you’ll have more shares. When new traders suddenly receive more shares in their portfolio, they tend to get flustered.
This blog explains what a stock split does to your stock investment, how your position is affected and why companies choose to undergo a stock split.
What is a Stock Split?
A stock split is when a company divides its existing shares into multiple new shares. If a stock is split, for instance, from a ratio of 2 to 1, then the share price would be cut in half, and the number of shares would double. If a share was valued at ₹1000, then following the split you will be given two shares, each valued at ₹500. The amount of your investment doesn’t change.
This is typically done to make the shares more accessible and desirable for retail investors and boost trading volume. It doesn’t add or subtract from the company’s true value. It is just a change in the structure – not the fundamentals of the business.
What happens to your investment?
The next big question is how your investment will be affected when a company splits its shares. The bottom line is that the overall value of your investments won’t alter.
Suppose you had a total of ₹10,000 in shares prior to the split; then you will still have a total of ₹10,000 in shares after the split. The number of shares and the price per share are the only factors which change. Your ownership in the company also remains the same.
If you had 10% of a company prior to the split, this means that you will own 10% after the split. But investors may be acting on the stock as it’s much cheaper for more to buy and sell. This can result in increased liquidity and trading volume in the marketplace.
Impact on investor psychology and market behaviour
Although the stock may not be cheaper, many small investors think that the share price is more affordable when it is split.
This tends to boost demand and trading volume. It’s crucial to realise, however, that a lower price tag is not synonymous with an underpriced or cheap stock. The business hasn’t changed in any way, and it’s just the share structure. Occasionally, a stock split can be viewed as a positive sign among all stocks when they perform better and grow.
This can lead investors to become optimistic. However, savvy investors pay more attention to the long-term performance of the business than to recent price fluctuations due to splits. So, a stock split should not be interpreted as a reason to sell or purchase a stock, but rather a technical adjustment.
Conclusion
A stock split doesn’t impact the actual worth of your investment. It simply affects the price per share, in a way that the more shares that are issued, the lower the price. Many people think it’s profit or loss, but it’s really just a change of structure.
The company’s market value, your ownership stake and wealth do not change. It can, however, enhance liquidity and attract investors.
When focusing on upcoming stock split announcements, keep in mind that a split doesn’t necessarily make a company a better investment. Before investing in a company, always analyse its financial health, growth and long-term performance.
