Corporations may decide to make their shares more attractive by conducting a stock split. In this article we discuss why companies have stock splits and what happens to the shares.

Definition

A stock split occurs when the companies decrease the stock price and issues more shares so the market capitalisation stays the same. If a 2 for 1 stock split occurs the stock price is halved but the shareholder receives twice the amount of shares, so the total value remains unchanged. For example, an investor has a stock which has a share price of $100 per share and had 1,000 shares. The total holding was $100* 1000 shares = $100,000. If there is a 2 for 1 stock split, the shareholder now has 2000 shares but the share price is now $50 per share so the total holding value is unchanged (2000 shares * $50 = $100,000).

Why do companies do this?

A company may decide to conduct a stock split as they might want to make their shares more affordable to investors. If they decrease the stock price the stock becomes more accessible to more investors.

In 11 Aug 2020 Tesla (NASDAQ:TSLA)  announced a 5 to 1 stock split. The share price was trading more than $2,000 before the split and closed at $498.3 on the 31 Aug after the split. It would be difficult for the general public to amass a large holding of Tesla shares at over $2000 a share. By making the stock price appear cheaper it can drive demand for the stock up as more investors can afford the stock and this in effect can increase the stock price. Tesla share price is (at the close of 18.1.21) at $1,030.51.

Stock splits can also assist in making the stock more liquid. Lowering the share price can increase more buyers and sellers in the market. This can decrease the spread between the bid and offer which will make it more difficult for investors to influence the stock price.

Lauren Hua is a private client adviser at Fairmont Equities.

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