All About Stock Split: Example, Reasons and FAQs

This article will help you understand the concept of a stock split in detail. We will also discuss the 2022 Amazon stock split.

Table of Contents

• About Stock Split
• Who Initiates Stock Split?
• Example of Stock Split
• Amazon Stock Split
• Reason Behind Split
• Reverse Stock Split
• Impact of Stock Split on Investors
• Impact of Stock Split on Market Capitalization

What is Stock Split?

A stock split occurs when a company increases its shares to increase the liquidity of a stock. The total value of these shares remains the same but, the number of shares increases as the company splits a stock into parts. Common split ratios are 2 for 1 and 3 for 1. 

Who Initiates Stock Split?

A stock split is typically initiated by a company's board of directors as part of its financial and strategic decision-making process. Here's how stock splits relate to the board of directors:

1. Board Approval: Stock splits require formal approval by a company's board of directors. The board assesses whether a split is in the best interests of the company and its shareholders. They consider factors such as the current stock price, trading volume, and the potential impact on liquidity and investor sentiment.

2. Ratio Determination: The board decides the ratio for the stock split, such as 2-for-1, 3-for-1, or other variations. This ratio determines how many new shares will be issued for each existing share. The choice of ratio reflects the board's strategic goals.

3. Communicating the Decision: Once approved, the board communicates the stock split decision to shareholders through official announcements and regulatory filings. Shareholders need to be informed about the split's details and the timeline for its implementation.

4. Implementation: The board oversees the practical implementation of the stock split, ensuring that it complies with legal and regulatory requirements. This includes coordinating with the company's transfer agent to issue the additional shares to existing shareholders.

5. Market Impact: After the stock split, the board monitors its impact on the company's stock price, trading activity, and market capitalization. They assess whether the split achieved its intended objectives, such as making shares more affordable to a broader range of investors.

6. Future Considerations: The board may consider additional stock splits in the future based on the company's performance, growth prospects, and other relevant factors. They continue to make strategic decisions to benefit shareholders.

Understanding Stock Split With An Example

Let us understand this with the help of an example. Suppose, the company has 1000 stocks. Each stock is worth 20 rupees. Now, if the company wants to increase the number of stocks, then it will split them. This means that the total number of stocks increases but there will be no impact on the cost of these stocks. Suppose, the company has split it in the ratio of 2:1, then:

Earlier, 1 stock = 20 rupees

After a 2:1 split, 

1 stock= 10 rupees (per share price/number of parts in which split has occurred i.e. 20/2 here)

This means that the number of stocks will now be 2000 but the total cost of stocks remains at 20,000.

Understanding the Recent Amazon Stock Split

On 24th March 2022, Amazon announced the ratio, date and buyback of shares in its announcement on the stock split. It has announced a 20 for 1 split of the company’s common stock. From 3rd June, investors will have 20 shares instead of 1, 40 shares for 2 and so on. The expected date of trading based on the split-adjusted basis will start on 6th June 2022. This will be subject to the approval of the Amendment at the Annual Meeting of Shareholders which is scheduled for 25th May 2022. 

Once the split is approved, these shares will attract more investors and lead to an increase in the trading volume. This may even lead to the creation of a bullish catalyst for Amazon. Those who wanted to own Amazon shares will be able to do so after the split.

Benefits: Reason Behind Stocks Split

The following reasons facilitate this split:

1. One of the basic reasons behind the stock split is the inability of investors to afford the share. Once the share prices hit a specific high price, companies decide to go for a stock split since it will allow more investors to own stocks at a lower price. 
2. Once the number of shares increases, it leads to greater liquidity in stocks. The increased liquidity eases trading for buyers and sellers without any major impact on share prices. Due to this companies can repurchase their shares at a lower cost as their order will not increase the share price of more liquid stock.
3. The number of shares owned by investors increases. Now, after some time, when share prices reach a high, the investor will enjoy more profit.
4. Sometimes, the split is executed to meet the minimum criteria to stay listed on the exchange. This usually happens in the case of a reversed stock split.

Reversed Stock Split

The traditional split is known as forward stock split. Its opposite is known as a reversed stock split where the company reduces the number of outstanding shares and increases the share price. Here, the total amount remains the same as well.  This means that the market value of the company remains the same. 

Example of Reversed Split

Suppose an investor had 10 shares of a company. Each share was worth 300 rupees. This means that the investor has stocks worth 3,000 rupees. Suppose this company decided to undergo reversed split. It decides to consolidate 2 shares as 1. This means that the investor now has 5 shares.

• Earlier per share price= 300 rupees
• Per-share price after split = 300 x 2 = 600 (per share price x number of parts in which the share was consolidated i.e. 2 here)
• Total amount = 600 x 5 = 3,000 rupees

This means that the number of shares decreased but the per-share price doubled. Hence the total worth of stocks remains the same.

Reason Behind Reversed Split

Companies go for a reversed split when the stock price has gone below the minimum price required for listing. If the price goes down below this minimum amount, then the company can be delisted from an exchange. Some mutual funds do not invest in stocks below a preset minimum per-share price. Some investors value high prices more and therefore, companies may opt for a reversed split.

Impact of Stock Split on Investors

Usually, investors will not notice the impact on the number of shares they own. They will definitely notice the difference in the number of stocks that they owned earlier. This means that if a forward/ traditional split occurs, the investor will notice an increased number of stocks in their account. If a reverse split occurs, the investor will notice a lesser number of shares. 

Impact of Stock Split on Market Capitalization

• A stock split can impact market capitalization, but it doesn't change the overall value of a company. Market capitalization or 'market cap' is determined by multiplying total number of outstanding shares with per share current market price.
• When a stock split occurs, the company increases the number of outstanding shares while proportionally decreasing the share price. For example, in a 2-for-1 stock split, each shareholder receives two shares for every one they previously held, but the price per share is halved.
• The impact on market capitalization depends on how investors react. If the stock split is perceived positively, it may attract more investors, increasing demand for the stock and potentially driving up the share price over time. In this case, the market capitalization could grow.
• Conversely, if investors have a negative reaction to the stock split, it might lead to a decrease in the share price, resulting in a lower market capitalization.
• Overall, while a stock split can influence short-term market dynamics, it doesn't fundamentally change the value of the company. The total market capitalization remains the same, but it's distributed among a greater number of shares at a lower price per share.