Stock Split: Meaning and Causes


Meaning of Stock split

Stock split is a practice of splitting the existing shares into large numbers by company. It is one which increases the number of shares although the market capitalization value remains same. Stock split reduces the face value of shares for making them affordable by dividing them into multiple number of new shares. It is a very useful practice for infusing liquidity and to enhance the affordability of shares. 

Stock split is commonly used by companies when price of their share is too high and can’t be afforded by all range of investors especially the small investors. Decisions for doing stock split are taken by board of directors for raising required capitals easily by offering shares at reasonable price level. Ratios like 2-for-1 or 3-for-1 are the most common ones for stock split which means a shareholder will hold either two or three shares for every single share held by him earlier. Stock split is often confused with bonus shares by peoples. Bonus shares leads to changes in issued share capital whereas stock split only divides the authorized share capital of company.

Causes of Stock split

Various reasons due to which companies do stock split are as follows: –

  1. Stock split is done for reducing the market price of shares to make them more attractive in market. It is a practice which enables in making stock affordable for all types of investors. Highly priced shares move to high trading zone that is beyond the reach of small investors. Therefore, in order to bring them back to popular trading zone, stock split is done which decreases the face value of shares making it affordable for small investors. 
  2. It enables companies in increasing their share prices by boosting demand in market. With reduction in face value of shares, they become attractive to large number of investors. More peoples are willing to buy them as they are available at affordable rates that uplift the market demand and enhance their overall price. 
  3. This practice is used when higher profits are expected by companies in future and they want to convey it to shareholders. 
  4. Companies does not resort to reduction of cash dividends with stock split. In case, the firm is following a stable dividend policy, the investors may earn more amount of dividends. 
  5. It also makes rebalancing of portfolio simpler as portfolio managers are easily able to sell off low priced shares in order to buy new ones.