How a Stock Split Affects Your Portfolio
The decision that a firm has to take, whether it will undertake a stock split or not, significantly may alter the prices of stocks, and these decisions would most definitely have effects on its share prices without changing its general market value. A stock split, in general, is an event that affects the shareholders greatly but not exactly as they may expect it. Any investor who plans to navigate the market appropriately needs to be aware of how the splits work for stocks, what kinds of splits can exist, and how such events affect the shareholders. An article explores how stock splits affect shareholders and the long-term implications of a portfolio.
What is a Stock Split
It means that a firm increases its number of outstanding shares while decreasing proportionally the share price of the company to keep its market capital intact. Most companies that perform stock splits do it for the very reason of making their stock more easily accessible to all investors when the share price has gone too high and is inaccessible to smaller investors.
For instance, when a firm issues a 2-for-1 stock split declaration, then every shareholder will receive one additional share for everyone he has, but the price per stock drops by half. It now has the overall value of his stocks but the stocks now appear cheap to a new potential buyer.
Types of Stock Splits
The two most common types of common stock splits are forward stock split and reverse stock split. In each type, shareholder effects and market effects may differ.
- Forward Stock Split: This type of stock split is more common, whereby the company issuing the stocks increases the number of shares but decreases their price. Shareholders of the company hold on to the absolute value of their investment because they now have more shares priced lower per share. This type of split is viewed by some as a mark of corporate confidence and can attract an investor because of the lower value per share.
- Reverse Stock Split: In case of a reverse stock split, the number of outstanding shares declines, while the price per share increases. Reverse stock splits are often used by companies that want to increase their stock price, especially in cases where such a price has declined to the point of facing the risk of delisting at major exchanges. While reverse stock splits do not alter the net value of the shares, sometimes they are viewed as a bearish signal indicating that the company is doing poorly.
Impact of Stock Splits on Shareholders
Stock splits do not alter the fundamental value of an investment; however, they do affect shareholders psychologically and financially.
- Changes in Number of Shares: After the declaration of a stock split, shareholders would have more shares than they did initially. For example, if a shareholder-owned 100 shares and the company declared a 3-for-1 stock split, now he has 300 shares. However, the value per share is diluted proportionately; so the overall wealth remains the same. The increased number of shares might make investors feel richer, but the same amount of investment has not changed.
- Impact on Share Price: The most direct impact of a stock split is that of the price of shares. In the case of a forward stock split, it decreases the price per share, thereby making the stocks look more affordable to possible new investors. Lower-priced stocks can induce higher trading volumes and greater liquidity, thereby proving beneficial for shareholders in buying and selling their shares easily. This reduces the price of every share in a reverse split. It discourages small investors or even limits the trading level.
Market Perception and Sentiment
Most of the time, a stock split indicates that a company is perceived positively. Forward splits occur when a firm’s stock has been performing reasonably well, and its price has reached an unusually high value; this is a success and growth issue. Thus, it can create high demand for the stock as any investor would view the firm as doing well. Thus, that might raise the stock prices for investors after the split, but not necessarily.
However, reverse stock splits do sometimes impact the perception of the market. Companies perceive it as the last straw in staying in compliance with the rules of the stock exchange or trying to lift the image of the company. Investors tend to fear buying shares from a company that has performed a reverse split because they assume financial instability.
Stock splits may generate short-term buzz and market activity but generally have no long-term effect on shareholders. The intrinsic value of a company, or its financial well-being, is not affected by a split, and so the long-term performance of a stock is more a result of the company’s fundamentals rather than the split.
Those firms that continuously make good performance and split stock continue to attract investors. In some cases, this may result in increased demand for the stock that, in turn, pushes the price of the shares a bit higher in the future. On the other hand, if poor performance follows this reverse stock split, then the value of the stock may go down in the long term.
Conclusion
In favour of shareholders in the company, which has high access to their holdings, a stock split gives them increased liquidity in the stock markets. In no way do they make any change to the value of a particular investment. All, whether forward or reverse, ideas are strategic. A company sees a reason for doing any sort of restocking with a price as perceived by some of their investors. Knowing how a stock split works and its implications for a company’s long-run performance is in the best interests of any shareholder about knowing what management is after.
