Publicly listed companies often undergo process called stock splitting in an attempt to increase the value of the company. This article discusses what that process is, and the advantages and disadvantages of this business move.
What is a stock split?
All publicly listed companies have a certain amount of shares that are available to trade on the stock market. When a company decides to split its stock, the number of shares is increased so that each shareholder has more shares. For example, in a 2-1 stock split, a shareholder who owns 1 share will now own 2 shares.
Because the stock has been split in half, each of those 2 shares will be worth half the price of the original share, so the trading price of the company’s shares will decrease. However, the stock split does not decrease or increase a company’s overall value because while the number of shares has increased, the total sum of the share price is the same.
A stock split is usually performed by companies that have a high share price - a share price that is higher than those of similar companies trading on the market. The stock split makes shares more affordable to smaller investors. Because smaller investors can now afford to buy shares, the demand for shares often increases and in turn, the share price may increase.
Even though a stock split seems a good way to increase share prices and the total value of a publicly listed company, markets are far more complicated. There are many advantages and disadvantages to a stock split.
Advantages and disadvantages of a stock split
Advantages:
It shows company growth and value
A lot of companies with rapid growth and high value split their shares frequently - companies like Microsoft and Google are often splitting stock in order to keep their shares within a certain price range. When these companies split stock, it can signal rapid growth and a positive future for the company.
Share affordability is increased
When stock is split, each share of the stock is worth half of the value of its former price. Investors are attracted to the lower price - for example an investor who would not buy a share at $100 may buy one for $50. When shares are more affordable, the number of shareholders may grow.
The number of shareholders may increase
The higher the number of shares available, the more investors there are likely to be (especially when shares are more affordable). When a company has a larger and more diverse base of shareholders, the more likely it is that the company is protected from government regulations.
Price expectations are maintained
Investors may have a certain expectation of share prices for a certain type of company. When share price is very high, investors can be confused and upset that they cannot afford to buy shares in their preferred company. Splitting the stock maintains the price expectations held by investors, as well as driving up the number of investors.
Greater company control of shares
When a company’s shares have very high prices, and the stock is not split, this creates an opportunity for other people to create a business where they sell parts of the company’s shares. This takes the control of the shares from the company and gives it to other people. By splitting the stock, companies can control how many shares and potential investors there are.
Disadvantages:
Shares are perceived as less valuable
Sometimes when a company performs a stock split, although shares may be affordable, they may be less attractive to some investors. Shares with a high price show that the company is performing well. Highly priced shares reassure the original investors that they have made a good investment, and also increases the demand of those shares in the future.
Stock splitting costs money
There are a lot of costs involved in stock splitting. A company has to make a Board of Directors resolution and then send notifications to all the shareholders. Since this process costs money and the actual stock split itself may not increase the value of the company, a process like this has to be carefully considered.
There is a risk of being delisted
Stocks have to maintain a certain value per share in order to be listed on the market. If a company splits its stock, and the share price falls dramatically, then the company runs the risk of having its stock delisted. For this reason, many companies undergo a reverse stock split in order to maintain their listing.
You may attract unwanted investors
When share prices are lower, there are a higher number of different types of shareholders. These shareholders may buy and sell more shares a lot more more frequently, which causes larger fluctuations in the price of stock. To maintain a high share price, companies may not want to split stock so they can avoid dramatic swings in the market.
Overall, a stock split is a relatively easy concept to understand. However, for a publicly listed company, there are many considerations to make before splitting stock. Whether or not a stock split is performed is dependent on how many potential investors the company would like, what type of investors the company wants to attract, and how the company will maintain the price of their shares on the market to avoid being delisted.
