What is a Stock Split?

Slicing the Pie: How Stock Splits Make Stocks More Appealing

Imagine a delicious pizza – a company's stock – that only a few people can afford. A stock split is like slicing that pizza into more manageable pieces, making it accessible to a wider range of investors. In the world of investing, a stock split is a strategic move by a company to increase the number of its outstanding shares, effectively lowering the individual share price.

In this chapter, we'll delve into the world of stock splits, exploring how they work, their impact on shareholders, and showcasing real-life examples from prominent Indian companies.

Understanding Stock Splits

A stock split is a corporate action in which a company divides its existing shares into a larger number of shares. Think of it like cutting a large cake into smaller pieces. Each shareholder receives more shares, but the total value of their holdings remains the same. The key here is that the company’s overall market capitalization (total value of all outstanding shares) stays constant. While the number of shares increases, the price per share is proportionally adjusted downwards to maintain the same overall value.

For example, in a 2-for-1 stock split:

If you own 100 shares of a company trading at INR 100 per share (total value: INR 10,000),

After the split, you'll receive 200 shares (each worth INR 50 per share), with a total value of INR 10,000.

Why Do Companies Split Their Stock?

Here are some key reasons why the companies implement stock splits:

1) Increased Accessibility: Lowering the share price makes the stock more affordable for a broader range of investors, potentially increasing market participation.

2) Enhanced Liquidity: By increasing the number of shares outstanding, stock splits can improve the liquidity of the stock. With more shares available, it becomes easier for investors to buy and sell shares, promoting a more active market.

3) Market Perception: A lower share price can make the stock appear more attractive to potential investors. This psychological factor can sometimes lead to increased demand and a positive impact on the stock price.

4) Signal of Confidence: Companies undertaking stock splits might signal their confidence regarding future growth prospects and financial stability. This can boost investor confidence in the company's long-term potential.

Let's see how some prominent Indian companies have utilized stock splits effectively:

• ITC Ltd.: In 2016, ITC Ltd. executed a 1:2 stock split, making their INR 10 face value shares more affordable (split into 2 shares of INR 5 face value each). This increased market participation and liquidity.
• Tata Consultancy Services (TCS): In 2018, TCS announced a 1:1 stock split, doubling the number of shares and halving the share price. This move, reflecting their strong growth trajectory, was well-received by the market.
• HDFC Bank: In 2019, HDFC Bank's 1:2 stock split lowered the share price, making it more accessible to retail investors. The increased affordability and liquidity positively impacted market sentiment.

Impact of Stock Splits on Shareholders

While stock splits don't directly change the value of your investment, they do have some key effects on shareholders:

1) Increased Number of Shares: Shareholders receive additional shares, increasing their total holdings. For example, in a 2-for-1 split, if you own 100 shares, you will receive an additional 100 shares, making it 200 shares in total.

2) Adjusted Share Price: The share price is adjusted downwards proportionally to the split ratio. For instance, if a stock is trading at INR 1000 and they execute a 2-for-1 split, the new share price will be INR 500.

3) No Change in Market Value: Remember, the total value of your investment stays the same. While the number of shares increases, the total value of the shares remains unchanged.

4) Enhanced Liquidity: Increased share count can lead to a more liquid market, making it easier to buy or sell your shares.

Case Study: Tata Consultancy Services (TCS)

Tata Consultancy Services (TCS), one of India’s leading IT services companies, executed a 1:1 stock split in 2018. This split doubled the number of shares held by each shareholder and halved the share price. The stock split made TCS shares more affordable for retail investors and enhanced liquidity in the market. The positive market response reflected investor confidence in TCS’s growth prospects and financial stability.

Conclusion

Stock splits are an effective way for companies to make their shares more accessible and enhance market liquidity. By increasing the number of shares and adjusting the share price, companies can attract a broader range of investors and boost market activity. Next, we will explore another critical corporate action: Buy-Back of shares. Stay Tuned!!