What is a stock split and why is it done?

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What is a stock split?
A stock split involves a mechanism whereby a company splits its total number of shares outstanding without changing the firm's market cap. Logically, stock split does not change value of the company, though it changes the face value of the share. 

As per the Securities Exchange Board of India (SEBI), companies can opt for stock split whose share price over a period of the previous six months was above Rs 500.

There are many corporates who feel that stock split will hurt interest of small-cap and mid-cap shareholders specially whose shares trade in low volumes.

However, Stock split concept was much relevant in physical shares era due to minimum lot and odd lot, in this demat era this concept does not make much difference.

Why stock split is done?

Stock splits are done when company feels that their stock price are too high and expensive for small investors. This is also done to increase liquidity as increasing the number of shares at lower price will boost liquidity.

How is it calculated?

Say, for example, a company with 100 shares of stock priced at Rs 1000 per share. The market capitalization is 100 × 1000, or Rs 100000. The company splits its stock 2-for-1. There are now 200 shares of stock and each shareholder holds twice as many shares. The price of each share is adjusted to Rs 500. The market capitalization is 200 × 500 = Rs 100000, the same as before the split.

Is it beneficial for investors?

As liquidity is increased due to stock split it is always beneficial for investors. And investors assumes that a stock split is an indication that a stock is doing well and many consider it as a buy signal.

However, when company fails to meet investors expectation, stocks may fall.


Read more about: stock split, investors, demat
Story first published: Saturday, November 3, 2012, 10:19 [IST]
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