What is a stock split; how is it important?

A stock split is a process through which companies can change the number of shares it has currently trading in the secondary market. Through this corporate action, a company is able to reduce or increase the number of shares without changing the market capitalization of the company.

In the past few years, international companies like Amazon, Alphabet, Tesla, and Shopify have introduced stock splits while closer to home Tata Steel had announced its own stock split in June.

For example, if a company has shares that are currently being sold for exactly $1000 then the company can do a 1-for-20 split. This will result in that one share worth $1000 being divided into 20 shares worth $50. This increases the liquidity of stocks in the market while the overall market capitalization remains the same, i.e. the overall value of the stock remains the same.

Though with scrips we often see price movement due to psychological factors, price movements immediately following a stock split are common. A stock split can be done in any ratio though 1-for-2, 1-for-3, and 2-for-3 are common split ratios. Usually, a stock split results in more trading for the company’s stock due to increased liquidity from a lower per share price.

Additionally, companies can combine stock in a reverse stock split to drive up stock prices, reduce trading and speculation, and lower stock liquidity. Earlier in the year, Amazon exercised a 20:1 stock split that resulted in its stock price soaring from around $125 to over $2,000.

As the overall value never changes, a stock split or even a reverse stock split doesn’t directly change the value of the stocks that an investor is holding in their portfolio.

Some companies never split their stock despite sky-high share prices. Warren Buffet-owned Berkshire Hathaway’s Class A shares have never been split, which currently has an eye-watering price of $422,047.

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