Understanding the Advantages and Disadvantages of Stock Splits

• Stock split increases the number of shares while reducing the share price proportionally, keeping the total value of your holdings unchanged. This adjustment makes shares more accessible without altering the investment's overall value.
  

• Stock splits enhance affordability, boost liquidity, and attract new investors, leading to increased trading activity. As an existing shareholder, you will see no change in the value of your holdings, only in the number of shares and their price.
  

• Stock splits do not increase a company’s market value and involve costs for regulatory and legal compliance. They may also dilute shareholder exclusivity and increase volatility.

As an investor, the value of the assets in your portfolio can fluctuate over time, sometimes due to changes in market conditions and at other times due to events like a stock split. A stock split can have different outcomes depending on the type of split that occurs.
 

In this article, let us understand the advantages and disadvantages of a stock split.

A stock split is when a company increases its shares and lowers the price of each share, but the total value remains the same. For example, in a 2-for-1 split, you get two shares for every share you had, but each share costs half as much. This makes the stock more affordable and can attract more buyers.
 

You might find yourself holding more shares or, in some cases, fewer shares. However, it is essential to note that while the number of shares changes, the overall value of your holdings remains unaffected.

Also read: Benefits of the stock market

Here are some of the advantages you can derive from a stock split:

1. Affordability: A stock split makes shares more affordable for investors, especially when prices have risen significantly. This allows more investors to buy the standard lot size, which may have been out of reach before the split.
2. Increased liquidity: By lowering the share price, a stock split can attract more investors, leading to higher trading volume and increased liquidity in the market.
3. Narrower bid-ask spread: The increased trading activity following a stock split can narrow the bid-ask spread, making it easier for investors to buy and sell shares at desired prices.
4. Attracts new investors: A lower share price post-split can draw new investors to the stock, boosting overall interest and participation in the market.
5. No impact on portfolio value: Existing shareholders see no change in the total value of their holdings, as the split only adjusts the number of shares, not the overall value.
    

Also read: Difference between shares and stocks

Here are some of the disadvantages associated with stock splits:

1. No increase in company value: A stock split does not boost a company’s value or market capitalisation but merely divides the existing shares, leaving the overall market cap unchanged.
2. Costs and compliance: Conducting a stock split involves expenses for regulatory compliance, legal support, and other related activities, which the company must be prepared to bear.
3. Potential loss of exclusivity: A stock split might attract a broader audience, which could dilute the exclusivity of the shareholder base, especially if the company initially aimed to maintain a high-net-worth investor profile.
4. Reduced face value risk: A stock split lowers the face value of shares, and if the company’s performance declines, the face value may decrease further, potentially impacting market perception.
5. Increased volatility: Stock splits can lead to heightened volatility, resulting in wider bid-ask spreads and increased short-term trading fluctuations.
6. Negative perception: Some investors might view a stock split as a sign of financial trouble or a lack of confidence in future performance, which could harm investor sentiment and negatively affect the stock price.

1. Apple

In August 2020, Apple (AAPL) executed a 4-for-1 stock split. Before the split, each share was priced at around US $540. After the split, the share price was adjusted to approximately US $135 (calculated as $540 ÷ 4).

An investor holding 1,000 shares before the split would have seen their shares increase to 4,000 afterwards. While Apple's number of outstanding shares grew from 3.4 billion to around 13.6 billion, its market capitalisation remained stable at around US $2 trillion.

Apple has a history of stock splits, having previously split its stock 7-for-1 in 2014, 2-for-1 in both 2005 and 2000, and 2-for-1 back in 1987. A company can split its stock multiple times to adjust share prices and make them more accessible to investors.
 

2. Reliance Industries Limited (RIL)

In 2009, Reliance Industries Limited (RIL), one of India’s largest conglomerates, announced a 1:2 stock split. This meant that each share was divided into two. The goal was to boost the stock’s liquidity and make it more affordable for retail investors. As a result, trading volumes increased, and the stock became accessible to a broader range of investors, expanding the company's shareholder base.
 

Also read: How to invest in the stock market

When a company announces a forward stock split, it can signal that management views the stock as attractive, potentially making it more accessible to a broader range of investors. This often leads to an initial rise in the stock price following the announcement due to this positive perception.
 

However, it’s important to remember that a stock split itself does not change the value of your investment. The split just increases the number of shares and reduces the share price proportionally, leaving the total value of your holdings unchanged. Without accompanying positive news, such as strong earnings or dividend growth, any short-term gains following the split might eventually reverse.
 

Typically, companies announce stock splits several weeks in advance, creating a period between the announcement and the actual split. This means you should avoid making investment decisions based solely on the split. Instead, consider the stock split as one factor among many. Base your buy or sell decisions on thorough research, your investment goals, risk tolerance, and other relevant factors.
 

A stock split does not affect a company’s core financial health or growth potential, but other decisions like adjusting dividends or issuing new shares can impact the company’s financial status and investments.
 

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