Stock Splits
By David Gass
Stock Split is a kind of corporate action wherein the existing outstanding shares are divided in order to boost the liquidity of shares. The prices of the shares are adjusted automatically in the stock market when the action is implemented. It needs to be clarified that the equity capital of the company and its net assets remain the same. For instance, assume that the board of directors of a company decides to go for a 3:1 stock split. In this scenario, if the existing value per share is $90, the new value per share would become $30, while the net worth of the stock would remain the same.
Liquidity
The main reason behind companies going for a stock spit is to increase the liquidity of the shares in stock the market. More liquidity makes the buying and selling of the shares of a particular company easier. The split is either referred in the form of ratio or percentage as per the convenience of shareholders. Liquidity is an important factor to be considered by the management of the company. It is defined as the degree of flexibility to purchase or sell the shares or securities without making an impact on the prices of that share. It is done for the betterment of the investors.
Reverse Stock Split
Reverse stock split is an action that increases the par value of a share, while the total number of the company’s outstanding shares decreases. In this kind of split there is no effect on the net equity capital. To clarify the concept, we can take the following example. If the board of directors of a company decides to pursue a reverse split of 1:5, a shareholder having 5 shares of that company will now own only one share, but the value of that one share will be equivalent to the total value of 5 shares.
Reasons for Opting Stock Split
Over the past few years, companies used to pursue stock splits in order to help brokerage firms, since brokerage firms used to charge commission on the basis of number of shares being traded. Also market had been welcoming greater liquidity. However, the same does not hold true in today’s market, as most of the brokers charge a flat rate, irrespective of the number of shares you want to trade.
An investor may have concern that he or she is capable enough to purchase shares of high value. But a greater number of shares at a reduced purchase rate per share after stock split would make an investor to feel comfortable in making positions the stock. In this way, companies with a higher price may go for a stock split and decrease the rate per share, eventually attracting prospective investors. The net value and overall stock value remains the same at the end of the day, with higher greater number of shares and investors.
The market is now equipped with softwares that can enable you to handle necessary documents related to stock splits. Softwares to understand the accounting procedure involved in this process are available in the market at affordable prices.
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