A successful venture manages its business well, continues to expand beyond geographical and technological boundaries. At first, the business chooses to get listed in a stock market (often over-the-counter) with an IPO to go public.
Listing shares on a stock market invites investors and helps a company grow with its vision. Often with the large companies, the share prices go beyond a certain point where only corporate investors can manage trading and average investors get shrugged off for a too-high share price.
The best-experienced tactic at that point to bring the share prices under control is to split the stocks. While controlling the share price and increasing liquidity are the prime reasons for a common split stock, there can be other factors involved too such as compliance with local regulations.
In general, a stock split is often considered a harmless decision to equity shareholders, but the implications can be traced only if the true purpose is known.
The analysis of a stock split depends on the form it takes, either a forward stock split or a reverse stock split. In a forward stock split, the company issue new shares in ratio to the base shares, and in a reverse stock split the company reduces the number of outstanding shares.
Implications of a Stock Split:
For equity shareholders, the stock split does not affect their shareholding ratio. Their total net worth remains the same after a stock split.
The tax implications are also neutral as there is no additional gain with new shares addition. For corporate investors and other stakeholders, the stock split comes with a positive signal of increased liquidity and confidence in the company performance.
From the company’s viewpoint, the stock split controls the share price that attracts more investors, increases the shares trading and liquidity for the company.
Stock market analysts and rating agencies value the signaling effects more than any indirect action about the company management, the share prices reflect on the stock markets quickly.
A stock split is often considered a powerful message of a strong share price (at the highest level) to the analysts and investors alike, which further boosts the stock performance in the long run.
Pros and Cons of a Stock Split:
In short, a stock split is a good omen for the company and its shareholders as it happens when the share prices reach a certain level, and that only happens when a company performs consistently well.
The market share price in an efficient economy is the true reflection of a company’s performance if it reaches a point where the BOD considers it be beyond retail investors that signal for strong company performance.
There are certain benefits with a stock split decision for which many listed companies opt for it:
- A stock split decreases the share price and makes it an attractive decision for retail investors
- Increased share trading increases the company liquidity
- The total market capitalization remains unaffected for the company
- Shareholders keep their percentage values and there are no tax implications for them either
- Stock market analysts and rating agencies take the decision as a positive signal that further strengthens the share price
There are a few downsides of a stock split often manageable:
- Stock Split is not a permanent solution for excessive share price for a company; many blue-chip firms have to do it time and again. Microsoft for example has performed a stock split as many as nine times since it’s IPO.
- Only tax implication for shareholders is on capital gains, increased shares may increase the tax burden in the long term.
- Shareholders may not be able to sell the additional shares quickly as any covenant may be attached with the stock split.
Largely for any corporation, a stock split is beneficial provided the action is performed by choice. In some cases, large public firms may by regulation be compelled to perform the stock split, which may not be perceived good publically.
Shareholders’ wealth remains unaffected; in fact, it increases in the long term as share prices generally increase after a stock split after an initial fall.
For the management, it’s an easy and innocuous method of controlling the market share price without damaging the company’s reputation.