What Is a Stock Split: Reverse Split, Pros, Cons, & Investors


In this article, I go into how and why a share split is carried out, as well as the effect of a split.

So, what is a stock split?

The word “split” comes from English and means share or divide. There are two different methods of split transactions a company can do; split and reverse split. In the case of a split, one share is divided into several, while in the case of a reverse split, several shares are added to one.

This is done in order to lower the share price (split) or raise the share price (reverse split), so that it becomes more attractive and easier to trade with.

The company’s value, and the shareholder’s holding, does not change in connection with splits, but is entirely a “cosmetic” measure.

This is how a stock split is carried out

A stock split is carried out by dividing the shares in a company – splitting. In this way, more shares are created in the company.

As more shares are created, the price per share also decreases by the corresponding amount.

Example:

When a company makes a split / reverse split, the terms are stated by writing the number of new shares, a colon sign, followed by the number of old shares.

A split 2: 1 means that you get two new shares for an old one. A tip to remember this is to replace the colon with the word “for”. Two for one. A reverse split 1: 2, one for two, means that you get a new share for two old ones.

Conclusion…

Everyone who already owns shares before the split is automatically allotted the corresponding share of new shares.

A stock split does not affect the market value of the company, nor the holding you as an owner already have. But why then does a company decide to implement a stock split?

Why do companies want to make a stock split?

There are a few different reasons to make a split, but the most common is that the company wants to make its share more manageable and attractive to investors.

A high price for a share can lead to it being difficult to trade and companies therefore often make it easier for their investors to reduce the price of the share.

A high turnover on a share is something positive, this usually leads to a more fair valuation.

When the price of a share is lower, this means that more investors can trade the share and sales rise.

It is e.g. not many small savers who can trade shares that potentially cost several hundred dollars. It will then be easier and more manageable for small savers to trade the share if the price of the share is around $10.

Another reason why companies want to make a split is that if the company wants to make a redemption of shares, this often becomes more complicated with a high share price.

How are shares affected by a split – is it good or bad?

It has been shown that statistically speaking, a stock split has a positive effect on the share price.

It is common for the price to rise before the split is implemented, and to continue to rise more than the average for up to a year after.

This is probably a result of more small savers opening their eyes to the stock and choosing to pick it up in their portfolio.

Reverse stock split

There are times when a company chooses to implement a so-called reverse stock split.

A reverse stock split means that instead of increasing the number of shares through division, shares are merged. In this way, the number of shares is reduced and the price per share rises.

The reason why a reverse stock split is carried out is also the psychological ones.

The price per individual share has fallen so low that the company is perceived as unserious. By merging shares and thereby raising the price, they want to appear more serious.

In this way, it is expected to attract more investors.

Example:

Furniture inc. has a share price of $0.2. Since the share can be considered too cheap and unserious, they decide to make a reverse split 1:10 so that the share price is raised. Ten old shares become a new one.

$0.2 x 10 shares = $2

The share, which previously cost $0.2, now costs $2.

How does a reverse split affect the future development of the share? – Is there an advantage to a reverse split?

Like a split, a reverse split should theoretically have no significance for the share’s future development. Theoretically, some value is added or taken away because the price of the share rises and the number of shares falls.

This is not the whole truth this time either, a reverse split has an effect on the share price.

One reason why a reverse split should have a positive effect on the share price is that the price of the share is in a more reasonable range.

This in turn can increase interest in the stock and increase the volume.

One thing that suggests that a reverse split has a negative effect on the share price is that it sends a signal from management that they do not believe that the share, on its own, will be able to rise to a more reasonable share price.

Also

Also, a slightly less probable reason why a reverse split can have a negative effect is that the situation is misunderstood by investors.

When the price of the share rises sharply at the reverse split, investors may perceive this as a price increase and start selling the share, which in turn leads to an increased selling pressure in the share.

I myself do not consider this reason to be particularly reasonable.

In an old study done on the subject, they came to the conclusion that on the day when the proposal was published that a reverse split should be implemented, the shares showed a negative return of 2.23%.

On the day when the reverse split was performed, the abnormal average return was -5.36%.

Other studies have also concluded that the return falls on the proposal date and on the day when the reverse split is carried out.

A reverse split thus usually has a negative impact on the share’s development.

When is it decided on a possible split or reverse split?

A decision on a company to perform a split or a reverse split is made at the Annual General Meeting.

It may be that companies that want to make a share split also need to change the articles of association.

In order for a company to carry out a split, it is required that more than half of the votes at the meeting are in favor of the decision.

Conclusion

How do I participate in a split or reverse split?

To participate in a split or reverse split, you need to be registered as the owner on the record date. Then the split or the reverse split is performed automatically on your account.

You will still own shares at the same total market value as you had before, but either more or fewer shares at a lower or higher price.

Sources

https://meridian.allenpress.com/accounting-review/article-abstract/78/4/1049/53291/The-Implications-of-Using-Stock-Split-Adjusted-I-B

https://www.jstor.org/stable/40473082

https://onlinelibrary.wiley.com/doi/abs/10.1111/1475-6803.00003

https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1475-6803.1996.tb00585.x

https://archive.aessweb.com/index.php/5002/article/view/1703

https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1468-5957.1985.tb00793.x

https://www.proquest.com/openview/84037bcb1885df4cd2f5c3802613d47b/1?pq-origsite=gscholar&cbl=48426

https://www.sciencedirect.com/science/article/abs/pii/S0378426607002804

https://www.sciencedirect.com/science/article/abs/pii/092753989390005C

https://ijar-iaikapd.or.id/index.php/ijar/article/view/103

Kevin

This article has been reviewed by our editorial board and has been approved for publication in accordance with our editorial policies.

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