In order to attract more investors, companies engage in a tactic called the stock split. This can allow new investors to buy stock at a better price, while rewarding current investors with a greater amount of stock and prevent dilution of their value. Many different types of companies use stock splitting as a strategic measure for attracting new investors.
A stock split changes the amount of stock that has been issued to the marketplace, altering the price of the stock to reflect this division. The most common splits are 2 for 1, 3 for 1, or 3 for 2. However, the 2 for 1 stock split example is by far the most common. For each share of stock held, two shares will be issued. The price of the stock is divided by two. In the 3 for 1 split, each share is divided by 3. In the 3 for 2 split, an additional share is given for every two shares, and the price is divided by 2/3rds. A “reverse” stock split can also be done. For example, in a 1 for 10 reverse stock split, 10 shares of the stock are rolled into one share whose value is 10 times the price. Reverse stock splits are also called stock consolidations or share rollbacks. Consolidating stock in this way increases the price, which often attracts investors who prefer stock prices in a certain range.
In effect, a stock split allows the company to change the number of shares that are held by investors without affecting the value of the shares. However, splitting a stock often causes the price to rise, as more investors look to purchase it at the lower “attractive” price. Secondly, stock splits are often performed after a stock price has risen significantly. This signals to investors that it is trending favorably. Third, the stock split narrows the bid/ask spread, making it easier to trade and increasing its activity in the market.
A look at a stock split example will help you to understand the advantages of this practice. Company A announces a 2 for 1 stock split. Its price is currently $80 per share. The investor has 100 shares at $80 per share, or $8,000 of stock in total. If the stock splits 2 for 1, the investor now has 200 shares at half the price, or $40 each. They still have stock worth $8,000 but the number of shares has doubled. The lower price of the stock often induces the investor to purchase more. It will also attract other investors, thereby raising the value of the investment as people seek to purchase the stock at its more desirable level.
The StockMarketEye User’s Guide has information on how you can enter a stock split for your investments.