Stock Splits 101

Fancy as they may sound, stock splits are one of the most intuitive concepts to understand in Finance. A stock split is a corporate decision to break a stock into multiple equivalent divisions while keeping the market cap of the firm same. Common forms of splits are 2 for 1 (2-1) or 3 for 1 (3-1).

Let’s understand.

Assume that Ambani announces a 5-1 (five for 1) stock split for RIL today. He tweets, “for every 1 share you hold on 30thMarch, you’ll get 5 shares on 31st. I’m splitting stocks in your face, Adani!”

Days passed by and 30th March came taking the value of RIL shares to ₹2k with around 1 cr shares outstanding (available for purchase) – making RIL’s market cap = ₹20 bn. Another day went by and 31st March smiled with a fulfilled promise of 5 cr shares outstanding, but – a big BUT – with each of them priced at only ₹400 (2000/5). This would inevitably be done to ensure that the market cap of the company remains the same as on 30th. 

30th March in this case would be the pre-split date and the split is known as a conventional split. Now, Ambani is no Trump and he just wouldn’t tweet and split the stocks if it fundamentally makes no sense. There are various reasons for why companies do that, significant one of them is to make a lesser priced stock available for small retail investors. Psychologically, people feel more comfortable buying a cheaper stock. Apple and Tesla did just the same in 2020.

Like these forward splits, we also have reverse splits, wherein companies consolidate your stocks. A 1:10 reverse split might entail the firm to take 10 stocks you own now at ₹100 each and give you one for ₹1k. This is majorly done to save the company from delisting (certain exchanges stop companies from trading if their prices go below a certain point) or to make these stocks more prominent. However, in these cases the market signaling is often negative.

So, that’s it. I’m sad Sunday’s over and that Trump tweets no more. But, more on my woes never.

Bye for now.