In my childhood, at times my mother used to send me to the nearby grocery store to get change, she used to hand me over a note of 500 and used to ask me to get 5 notes of 100 rupees each. I am sure most of us have faced this situation before the UPI era.

Now, if we try and breakdown this a little, what I was doing was dividing the whole value into different denominations for easy and effective use. A similar kind of corporate action is seen in the securities market termed as Stock Split.

Stock Split is a corporate action where a company divides its existing shares into multiple shares. The primary goal of a stock split is to make the shares more affordable and increase their liquidity in the market. This process does not change the overall market capitalization of the company, as the total value of the shares is divided among a larger number of individual shares. If we were to understand the same via an example, say you have one note of INR 100, so in an event of stock split, this note will be divided into 10 notes of INR 10 each.

Let’s breakdown the common jargons of a stock split:

Split Ratio: Companies announce a specific ratio for the stock split, such as 2-for-1, 3-for-1, or any other ratio. For example, in a 2-for-1 stock split, shareholders receive two shares for every one share they previously held.

Share Price Adjustment: After the stock split, the share price is adjusted proportionally based on the split ratio. If the stock was trading at INR 100 per share before the split and the split ratio happens to be 2-for-1 split, it would now be trading at INR 50 per share after the split.

Unchanged Market Cap: The Market Capitalisation of the company remains unchanged as the number of shares increases and the share price decreases. In our example, say Mr. X was holding 1 lakh shares at INR 100 each before the split, then after the split he’ll be holding 2 lakh shares of INR 50 each, maintaining a portfolio of INR 1 crore.

Stock split is taken as a positive signal by the street as could be seen in the case of Eicher Motors in 2020, the stock was trading at levels of ~INR 22,000 which at times becomes difficult for many investors to invest, so when the company announced a split in the ratio of 1:10 and the stock rallied by more than 23% in the immediate 6 months and the trading volume surged to the ~8x of the previous volumes enabling a better price discovery.

Also, in case of Hindustan Aeronautics Ltd. which announced its split in Sept’23, the stock has rallied almost 30% from there.

Now, you might be wondering, that why do companies opt for this?, So, Companies generally split their stocks when they believe that the share price is too high for most people. By splitting stocks and cutting the price per share, they intend to open up the opportunity for more potential investors to buy into the company.

As we understood the reason why companies do it, a thought which might be wriggling in your head would be, how we, as investors can benefit from this? So, Investors can benefit from stock splits in several manners. Here are some of the key benefits of Stock Splits: 

· Improve Liquidity: The division of existing shares into a larger number of shares often results in a lower stock price. This increased affordability may attract more investors, thereby enhancing liquidity in the market. Improved liquidity makes it easier for shareholders to buy or sell shares without significantly impacting the stock's price.

· Improve Liquidity: The division of existing shares into a larger number of shares often results in a lower stock price. This increased affordability may attract more investors, thereby enhancing liquidity in the market. Improved liquidity makes it easier for shareholders to buy or sell shares without significantly impacting the stock's price.

· Psychological Impact: Some investors perceive lower-priced stocks as more affordable, even though the economic value of their holdings remains the same. This psychological impact might attract new investors and potentially contribute to a positive sentiment surrounding the stock.

· Increased Trading Activity: The reduced stock price may encourage increased trading activity, particularly among smaller investors who find the lower prices more manageable. Higher trading volumes can create a more dynamic market for the stock.

· Potential for Share Price Appreciation: While a stock split doesn't inherently increase the intrinsic value of a company, the positive perception associated with a split may attract more investors, potentially leading to increased demand for the stock and, consequently, upward pressure on its price.

· Signal of Confidence: Companies may use a stock split as a signal of confidence in their future growth prospects. A split may suggest that the management believes the company's stock price will continue to rise.

After understanding the reasons for a stock split, lets understand the key dates for investors for the same as well:

Announcement date: First, the company will publicly announce the plans for the split, as well as pertinent details investors need to know. This information generally includes the split ratio and when it will happen, including the record date and effective date.

Record date: This is an important date when it comes to accounting, but it isn't terribly important for investors to know.

Effective date: The date when the new shares show up in investors' brokerage accounts and the shares trade on a split-adjusted basis. This may sound complicated, but it's quite simple in real-world situations. On the morning of the effective date of a stock split, the increased number of shares will appear in your demat account, and the share price should be adjusted accordingly.

Stock splits can often stoke demand, whether through increased accessibility, demand from fund managers, and/or the “signalling effect.”

To understand more about such interesting concepts along with further interesting examples, checkout my course on Basics of Stock Market.

Till then take care, jai hind and bye-bye!!