Is a stock split good?
A stock split can change the number of shares in an investor’s portfolio, but it’s not necessarily a bad thing. Here’s a basic explanation of what stock splits are and why investors rarely need to worry about them.
Stock split definition and example
A stock split happens when a listed company’s board of directors decide to alter the number of outstanding shares from the company in the sharemarket. Companies with a high share price often initiate stock splits.
What happens in a stock split is that, once the board decides on the split ratio, the company will issue new shares to existing shareholders according to the approved ratio but without altering its market share.
For instance, a board that executes a two-to-one split would issue one unit of share for each unit an existing shareholder owns. However, this move will not alter the market share of the company because its share price also adjusts accordingly.
Consider a shareholder who owns 100 shares worth $5 per unit, for a total value of $500. In a two-to-one stock split, they would be given another 100 units once the split takes effect, but the share price would go down to $2.50 per unit, keeping their portfolio’s value at $500.
Reverse stock split
Reverse stock split is usually executed when a company’s share price is low so that companies can avoid getting delisted from an exchange. Instead of issuing new shares to give existing shareholders, the issuing company decreases the outstanding shares in circulation.
A company that executes a reverse stock split would still retain its market share but shareholders would hold fewer units of shares. The share price adjusts accordingly just like a stock split.
For example, a listed company that has seen its share price remain stuck at 50 cents per share for the past half-year. The board may decide to do a one-for-10 reverse stock split to increase the price per unit. When this happens, the number of shares an investor owns will be divided by 10.
For instance, an investor who owns 100 shares worth 50 cents per unit will only own 10 shares worth $5 per unit when the reverse stock split takes effect. In both cases, the portfolio retains its $50 market value.
How do stock splits affect dividend payouts?
Stock splits change the number of units in a shareholder’s portfolio. So, does it follow that the amount of money they receive also gets affected? Not really. Dividend payouts are treated similar to the share prices.
As explained above, share prices decrease when a stock split is executed and dividends follow suit.
Going back to the two-for-one stock split example, assume that the company announced a dividend of 10 cents per unit. The shareholder would then expect a $10 dividend payout for 100 units. What happens after the stock split is that dividends will also be split so that shareholders are given 5 cents per unit, and they can still expect a $10 dividend for 200 shares.
The same is true with reverse stock split example. To illustrate, assume that the company announced a 5 cent dividend per unit of share. With the original portfolio, the shareholder can expect a $5 dividend for 100 shares. When the reverse stock split is executed, the dividend per share becomes 50 cents, which means shareholders can still expect a $5 dividend for their 10 shares.
However, the above is only correct if the stock split takes effect before the record date. If a split takes effect after the record date, shareholders will not be entitled to dividends from the new shares. Likewise, investors are only entitled to a portion of the dividends in the case of a reverse stock split.
Is a stock split good?
Stock splits don’t really affect investors much. However, it may be considered good because the new market value usually makes the company’s shares more attractive to investors.
In the case of stock splits, expensive shares become accessible to more investors and may drive growth and facilitate trading. Reverse stock splits, on the other hand, may prevent the company from getting delisted and save investors from potentially huge losses.
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