Many investors are trying to understand the stock split process as IRCTC recently has announced a stock split. Companies do many things to attract investors – the most common corporate action is the distribution of dividends. The next on the list is stock split. Every investor should know about it irrespective of whether they hold IRCTC or not.
In this article, we will talk about everything you need to know about a stock split.
What is a stock split?
A stock split is a corporate action in which a company decides to split its share at a specific ratio. The first thing you should be clear is – It does not change anything for the company or investors in financial terms. However, there are other benefits (we will talk about it). When a stock split happens, investors have a higher number of shares of the same company. Let us understand it with an example of IRCTC – The company has announced a stock split of 1:5.
Assume you hold 100 shares of the company before the record date. After the stock split, the number of shares in your account will increase to 500. However, the total worth will not change. If the share price is Rs 4000 (we have used approximation) on the record date, it will reduce to Rs 800 after the split price. The before and after picture of your net capital will look as below –
Before Split – No. of stocks * price of one unit = 100 * 4000 = Rs 4,00,000
After Split – No. of stocks * price of one unit = 500 * 800 = Rs 4,00,000
You can see from the above numbers – nothing changes for you in monetary terms.
There is the face value of the company that also changes. It is the price the company’s share was valued at the start of the business. For most companies, you will notice face value being Rs 10. The face value of IRCTC is Rs 10 at the moment. After the split, the face value of the stock will reduce to Rs 2.
What are the advantages to shareholders?
Now that you have understood the stock split, you must be wondering about its advantages. So let us dive straight into the benefits:
The share is more affordable – As mentioned above, there are no financial benefits when a stock split happens. However, when it comes to investors’ psychology, there is a definite shift. Investors consider Rs 2000 shares expensive. They think it is even more expensive – when the share price has increased exponentially in recent times. An investor who has seen a stock price at Rs 300 a couple of years ago will hesitate to buy it at Rs 1500 (Note – these are the general mindset of investors and not the right one in stock investing).
Also, when a share price is high, Rs 2000 and above, it gets out of reach of most retail investors who invest a small amount every month. The mindset is to buy ten shares at Rs 200 than buy one share at Rs 1000. When a stock split happens, the stock is more accessible to even retail investors. When the stock split takes place, many investors start buying it if the company is good.
Increases liquidity – As mentioned above, Rs 5000 stock is not affordable to most investors. You can see the traded volume of high stock price companies. You will notice, the trading volumes are not high. When the stock price reduces, more investors start buying the stock, and the liquidity increases.
Potential Increase in share price – In line with the above points, since the share price has reduced and more investors start buying it, it could lead to a higher share price. Note – nothing has changed fundamentally. It is just that more people are buying, the demand increase, and hence the stock price.
Do investors have to do anything to receive shares?
No, investors don’t have to do anything. Just like dividends given by the company are automatically credited to your account. Similarly, the additional shares will credit to your Demat account at the same time when the price changes (get reduced). The activity usually happens after four to five days from the record date set by the company.
Is split share different from bonus issue?
Yes, both are different. Do you know why companies give dividends? The company credits dividends to shareholders’ accounts when it has a surplus of cash reserves. In some cases, the company may decide not to distribute dividends but give bonus shares to the shareholders. The number of shares shareholders receive will depend on the number of shares they are currently holding. Unlike stock split, the number of shares in bonus shares increases and also your total capital.
We hope the article answered all your questions about the stock split and increased your financial knowledge. If you are clueless about where to invest or have lost money because you invested based on tips – we have a solution. Download Jarvis now and start your investment journey.