A stock split is a process whereby a company splits a unit of its shares to make it more available and affordable.
Example: A company has 500,000 units @N4 per share now decides to have a 2 shares for every 1 share held, stock split its shares.
Previously – 500,000 shares @ N4 each
Stock Split of 2 for 1
Now – One Million Units @N2 each.
Other Examples of a Stock Split
A stock split can also be a 5 for every 2 held or a 10 for every 1 held etc. and as above it all depends on the company’s strategy and the number of shares it wishes to increase. These are some examples;
Previously – 500,000 ordinary shares @N4 each
A stock split of 5 for every 2 held
Now – 1,250,000 ordinary shares @ N1.6 per share
Previously – 500,000 ordinary shares @N4 each
A stock split of 10 for every 1 held
Now – 5,000,000 for @N0.4 per share
Formula
I like to use the formula below for calculating stock splits and I think it will work for you too. Let us use the last example above of 5 for every 2 held.
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A= 5
B=2
C= Current Outstanding Shares
D= New Outstanding Shares
D= C multiplied A divided by B
To get the new share price, just divide the Total Value pre Stock Split (which doesn’t still change) by the new outstanding shares (D) or Price divided by A multiplied by B.
Why Companies Carry Out Stock Splits
Despite the fact that the value of the company theoretically remains the same, companies still embark on Stock Splits for a number of reasons.
We will use the following illustration to help explain the reasons. Two companies A and B have the same market value of N10million per share. However company A has a share price of N100, 000 per share and therefore only has 100 ordinary shares outstanding. Company B on the other hand is priced at N1 per share and has 10 million ordinary shares outstanding.
Makes the share price more affordable
Whilst both companies above still have the same market value of N10million Company A is less affordable than Company B. To understand how this can affect you, imagine you only have N100,000 to invest in the stock market and wish to spread the investment amongst a diverse portfolio of stocks. You will only be able to buy shares in Company A because a share in the company cost N100,000 which basically is all of the money you have available to invest.
The only option you will have is to avoid the stock of company A completely or invest in a mutual fund that has Company A in its portfolio. Contrast this to Company B where, by splashing just N20,000 you will own 20,000 shares in the company as against 1 in company A.
Remember, the value is the same for an investor with 1 share in Company A and one with 1,00,00,00 shares of Company B. The only difference is that Company B allows you to spend some of your money investing in it whilst for Company A it means you probably have to spend all you have.
Makes the Shares More Available
As in the example above, Company A has only 100 ordinary shares available compared to Company B with 10million ordinary shares. Company B is therefore more liquid than Company A as more people have the opportunity to own shares in the former.
Meeting Listing Requirements
Some Stock exchanges, like the Nigerian Stock Exchange requires as part of its listing requirements a sizeable number of shares of the company to be available for trade before been listed. Based on this most companies in their desire to meet listing requirements in exchanges often embark on share splits to increase the number of shares available. Company A for example, will not pass a listing requirements for the Nigerian Stock Exchange.
How Does Stock Splits Affect Shareholders?
For a shareholder stock splits will result in no change to the ownership structure of a company. Even though, they have more shares, the increase is in proportionally distributed. However, this may or may not translate to increase in value. For example, a stock split may translate to increase in value due to the increased availability and affordability of the stock. The resultant increase in demand can help push up prices and ultimately the value of the company.
Conversely, investors may also view Stock Split in a negative light. The increase in liquidity of the stock may soon make it so tradable and attractive to bears. Because it is now available in tradable quantities a situation where you have more sellers (bears) than buyers may affect the share price negatively.
Stock splits may also result in huge cost to the company as they now have more shares available for the Registrars to manage. This cost is typically passed on the shareholders as it reduces profitability.
What you must do after a stock split
As a shareholder of a company which has just concluded a stock split, you must give your stockbroker a call or pay them a visit to get a full understanding of its implication on your shares. Once you understand it, you must then ensure you get the full compliments of your new shareholdings and make sure it is proportionally equal to what it was pre-stock split.
I have shares in a company but have never bothered about stock split
Not all companies embark on stock splits, however you can independently find out if a stock split had been carried out in the past. Historical shareholding structure of companies can be found in every annual report released by companies. If it contains information about a stock split that you are unaware of then you must sought the advice of your stockbroker to regularize.
Do I get a Share Certificate?
After a stock split has been concluded, you are given new share certificates representing the new shares. However, you may also been given back the shares electronically with the Central Security Clearing System.
Conclusion
Stock splits in general do not affect the theoretical value of companies. However, market sentiments and perception can make post stock split value of companies rise or decrease. Stock splits are also more associated with companies with highly illiquid stocks and higher than average industry share price.
