A stock split is the division of existing shares into multiple shares, and is done generally by the company to boost the liquidity of the shares and you need to know a bit bout the forex exchange to deal with this. Even if you are not aware of the different trading platforms, then also you may face some problem. Even if the total number of shares outstanding increases by a specific multiple, the total value in dollars of the shares is still the same. Let’s break this concept down even further.
Stock Split Ratios
As mentioned, the total dollar value of the shares remains the same when compared to the amount prior to the split. This tells us that the split does not add any value to the shares.
The most common stock split ratios, though, are 2 for 1 or 3 for 1. This means that a stockholder will have two or three shares for every shares held prior to the stock split.
A stock split is also typically called a forward stock split, and scrip issue, bonus issue, capitalization issue, or free issue in the United Kingdom.
How does it work?
Once a company implements a stock split, the share prices automatically adjust in the markets. The company’s board of directors can split the stocks in any number of ways.
For instance, a stock split may be 2 for 1, 5 for 1, 10 for 1, 100 for 1, and so on. This entails that the number of outstanding shares in the market will increase. In a 3 for 1 stock split, an investor will hold 3 shares for every single share he held before the split. Thus, the outstanding shares will triple.
Meanwhile, the price per share of the stock after the split will be reduced. For our example above, the price will be divided by 3.
Therefore, the company’s overall value that is measured in terms of market capitalization would remain the same.
Why split stocks?
Companies can perform stock splits when the stock price becomes too high. When the stock price is too high, investors cannot easily acquire the standard board lot of 100 shares. It makes the stock and therefore the company to potential investors.
Another reason is that if the number of shares outstanding is higher, it can result to greater liquidity for the stock. Greater liquidity means can bolster trading. As a result, it can narrow the bid and ask spread.
Boosting the liquidity of the stock means easier trading in the market for buyers and sellers. Liquidity gives a very extreme flexibility in which investors can buy and sell shares in the company. They could do that without influencing the share price too much.
In theory, a split does not have any effect on the price of a stock. However, it frequently results in renewed interest from investors. This can potentially have a positive impact on the stock price. Though this can only last for a certain period of time, stock splits done by blue chip companies still provide a great way for investors to accumulate more blue chip stocks.
Many of those companies usually break the price level where they previously implemented a stock split. Because of that, they are compelled to do some stock splits yet again.
Stock splits are a good way to invest in better companies, so you must always be on the lookout for these opportunities. Additionally, you must also be aware for some possible risks you may suffer if you invest in stock splits.