Purpose of a Stock-split
Stock-split is announced when the company feels that the stock is highly priced and different investor classes are not able to bet on the stock. Also, stock-split is carried out to infuse liquidity in the stock. Post the stock-split, with increase in liquidity price of the stock is determined by the market forces of demand and supply.
Working of a stock-split
In case a company has 10 crore outstanding shares of face value Rs. 10 priced at Rs. 1000/ share. Market capitalization (no. of outstanding shares x current market price) for the company turns out to be Rs. 10,000 crore.
And in the event when it announces a stock split in the ratio of 1:5 then post the stock-split total number of shares of the stock would increase to 50 crore with Rs 2 face value and share will then be priced at Rs. 200. So even though, the price per share has decreased, market capitalization remains the same (50 crore x 200) So an investor with 200 shares of the stock before the stock-split will have a total of 1000 shares after the split.
What should be investors stance on stock-splits?
The lower price of the share post the stock-split should not be the sole criterion for investing in the company share. It has been observed by brokerage houses that investors in the expectation that benefit will accrue to them on account of increased trading activity invest in the stock. However, experts suggest that when considering the company stock that has announced a stock-split, one should examine company valuations and the underlying fundamentals.