What is a stock split?
A stock split is what happens when a listed company splits its outstanding shares into multiple shares. The market capitalization of the company and the investment value of each shareholder remains the same during a stock split, but the value of each share is reduced as the number of shares increases.
The purpose of a stock split is to attract new investors in order to increase market capitalization in the medium and long term. Often times, when a company divides its stock – or even announces its intention to do so – it causes stock price volatility. Many investors see a stock split as a sign that the company is performing well, so the value of the stock increases due to investor optimism. Traders also positively view stock splits as they can create market volatility, which leads to more trading opportunities.
When stock splitting, a company will first determine a stock split ratio – this is the ratio by which the company will multiply the number of existing shares and divide the current share price. For example, if the split ratio is 2: 1, the number of shares will double and the share price will be halved. To calculate the value of a stock following a stock split, simply divide the price before the split by the first number in the ratio, like in this example:
You own ten shares in a company, each valued at £ 100 before a 2: 1 stock split, which gives you a total of £ 1000 of shares. After the split, you own 20 shares worth £ 50 each (£ 100 ÷ 2). The total value of your investment remains the same at £ 1000.