What is a stock split and how does it affect the investors at large?
One of the most enigmatic financial and investment strategies of the companies has been the stock split. Why is such a stock split done and how does it affect the company, its finance? How does the stock split affect the investment decision of the investors?
With a stock split the number of shares is increased through a proportional reduction in the par value of the stock. However with a stock dividend the par value of the stock does not get reduced.
As a result, the common stock, the paid in capital amount, the retained earnings does not change with a stock split. The total shareholder equity also remains unchanged. The only change is in the par value of the stock which now becomes half of what is used to be.
Let us see through an example:
Company: X
Total shares: 1000
Par value : $ 90
Total book value = $90 x 1000 = $ 90,000
Paid in capital $ 10,000
Total shareholder equity $100,000
Now with a stock split it would look like this:
Total book value = $ 45 x 2000 = $ 90,000
Paid in capital $ 10,000
Total shareholder equity $100,000
The only change is the change in the par value of the stock, which, on per share investment valuation is half of what it was earlier. A stock split is generally conducted for reasons when the company want to achieve a substantial reduction in the market price per share of the its traded common stock. The main objective of such a move is to bring the stock price within the purchasing purview of a large number of smaller investors.
Such a strategy makes the stock more popular with the investment fraternity because it requires a less amount of capital/investment to own a part in the company. It also mitigates the stock risk by distributing the ownership among a large number of investors. Such strategic investment and financial moves also help in thwarting any hostile takeover bid or allowing some scrupulous players in the market to manipulate the stock prices of the company.
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