Every publicly listed company has a fixed quantity of outstanding shares. A stock split is the board of director’s decision to issue more shares to present owners in order to increase the number of shares outstanding. A shareholder obtains an extra share for each share they currently own, for instance, in a 2-for-1 stock split. Therefore, following a 2-for-1 split, a firm with 10 million outstanding shares before to the split will have 20 million outstanding shares.
A split of a stock also has an impact on its price. The stock price will drop following a split (since there will be more shares outstanding). As a result, even if a stock split raises the number of outstanding shares and consequently drops the share price, the market capitalization of the business stays constant. The board of a firm may decide to split shares if the price of the company’s stock rises to a point where certain investors would find it unsettling or if it surpasses the prices of comparable companies in the same industry. Even when the fundamental worth of the firm remains the same, a stock split may provide the impression that the shares are more reasonable. Additionally, it may make the stock more liquid.
Even while there can be a dip just after a stock split, shares might also rise as a result of the transaction. This is due to the possibility that small investors would view the stock as more inexpensive and purchase it. As a result, the stock’s demand is increased and prices rise. A stock split signals to the market that the company’s share price has been rising, and people may expect this growth will continue in the future. This is another cause for the price increase. Prices and demand rise even more as a result.
To increase the accessibility of its shares to a wider range of investors, Apple Inc. divided its shares seven for one in June 2014. In addition, each share that an existing shareholder had before the stock split was increased by six. As a result, an investor who had 1,000 shares in AAPL before to the split now had 7,000 shares. Apple now has 6 billion shares outstanding, up from 861 million shares previously. What is fundamental analysis? One technique for figuring out a stock’s fair market value is fundamental analysis. The company’s $556 billion market valuation, however, did not really alter. Due to the higher demand brought about by the reduced stock price, the price rose to a high of $95.05 the day following the split.
A reverse one-for-five split, for instance, would result in the conversion of 10 million outstanding shares at $0.50 cents each into 2 million shares outstanding at $2.50 a share. The business is still valued at $5 million in both situations. Citigroup reverse split its shares one-for-ten in May 2011 in an attempt to lower share volatility and deter trading by speculators. Its share price jumped from $4.52 to $45.12 after the reverse split. An investor received one share in exchange for every ten shares they owned. Short sellers are not significantly impacted by stock splits. A split might bring about a few factors that have the potential to affect the short position. They have no effect on the short position’s value, though. The number of shares that are shorted and the price per share represent the largest changes to the portfolio. When a stock trader shorts a stock, they are borrowing the shares with the understanding that they will give them back eventually. For instance, if an investor shorts 100 shares of XYZ Corp. at $25, they will eventually have to give the lender back 100 shares of XYZ.
The value of the shares is divided together with the company’s share split. Assume, for instance, that XYZ Corp. was valued at $20 at the time of the two-for-one split; following the split, the share count doubles, and the value of the shares drops to $10 from $20. Following the split, an investor who originally purchased 100 shares at $20 for a total of $2,000 will now own 200 shares at $10. A short investor would have owed the lender 100 shares before the split. They will owe 200 shares (at a discounted price) following the split. The short investor will purchase 200 shares for $10 in the market and return them to the lender if they close their position immediately following the split.
After deducting the expense of terminating the short position ($10 x 200), the short investor will have achieved a profit of $500 (money received during the short sale: $25 x 100). Specifically, $2,500 – $2,000 = $500. 100 shares at $25, or 200 shares at $12.50, was the entry price for the short position. On the 200 shares they borrowed, the short made $2.50 per share; if they had sold before the split, they would have made $5 per share.
Companies that have witnessed significant growth in share prices are the ones who often adopt a stock split. The market capitalization, or the worth of the firm, remains constant despite a growth in the number of outstanding shares and a fall in the price per share. Consequently, stock splits increase share prices for smaller investors while also increasing marketability and liquidity.