You may have heard the news that many companies decide to split or reverse split their shares in the market. It is solely done for the purpose of creating a buzz in the market and nothing else. Why the company opts for the splitting of the shares? Does this have any impact on the value of shares investors hold? These are some of the prominent questions that sprout up into the mind after going through the news. But before we proceed any further, let us first understand the concept of stock and reverse split. So, without wasting any time, let us get started.
What Exactly is a Stock Split?
The strategic move which changes the company’s stock price, but does not increase the total market value directly. In layman’s language, it is essentially dividing the existing shares into many shares. It means a company will release or issue new shares to its existing shareholders in order to increase the number of shares each one holds. So, when a company decides to split its stock, it may use the ratio which is 2- for -1, 3- for – 1 and 3- for -2. Moreover, it means that no extra value is created or damaged via stock split. It is like having a Rs 200 note and you changed it to Rs 100+ Rs 100 = Rs 200 note. Now, the main point of consideration here is that the total value of the currency that you hold remains unchanged but the number of notes, you actually have has now increased, which you can spend accordingly.
Similarly, If an XYZ company has 100 shares of Rs 10 face value and the company announces that it will split the stocks into Rs 5 per share. Now, the important thing to note here is that the same share of Rs 10 will now get converted into 2 shares of Rs 5 face value. If you have 20 shares of the company, then you will now have 40 shares of the same company after the stock split.
What is a Reverse Split?
In simple terms, it increases the share price of the company. Reverse stock split essentially means a company’s total shares outstanding is reduced, which results in the price of each individual shares to go up. Suppose, if the company’s stock price falls below a certain point, then this may cause the risk of being delisted. s
Suppose, an ABC company decides to follow the ratio of 2:1 for reverse splitting the shares, which means for every two shares that the investors have would be replaced by the one share. To make the picture more clear, let us look at another example when a company announces the reverse stock split of 1 for 100, then it means that the investors will actually receive the 1 share for every 100 stocks held by them.
Let us take another example: The shares of an XYZ company were Rs 1 per share before the reverse split and the investor had 100 stocks, the investor-owned Rs 100 of shares. After the reverse split, the investor now has 20 stocks of Rs 5 each, still Rs 100 shares.
Know why Companies Use Stock split and Reverse Stock Split?
There are ample reasons for the companies to split their stock as and when the stock price of the company rises, it makes difficult for the investors to invest or buy more stocks, so to make it easy, a company uses a stock split strategy to lower the price of the individual shares to attract more investors. The companies apply this strategy during the rapid increase in the stock price as compared to their competitors. Many companies also apply this strategy to make their shares more liquid and attract the investors.
On the other hand, some companies use the reverse stock split strategy to reduce the number of its outstanding shares without affecting the total market value. This makes the price of the shares to go up and this decision prevents the shares from being delisted. One of the basic reasons, the companies follow reverse stock split strategy is to meet the price requirements of the mutual funds.
The Closing Words
It is important that before gearing up to trade in the stock market, you must be armed with the full knowledge of the split and reverse split, which may prove to be highly beneficial for you. If any queries related to the why companies use stock split and reverse stock split strategy, you can leave your comment in the below given comment box.