A stock split occurs when a company increases the number of its stock shares outstanding without increasing shareholders’ equity. To you as an investor, that means you’ll own a different number of shares but they’ll add up to the same amount of money. A common stock split is 2-for-1. Say you own 100 shares of a stock trading at INR 1000. Your account is worth INR 100,000. If the stock splits 2-for-1 you will own 200 shares that trade at INR 500. Your account is still worth INR 10,000.
Companies split their stock to make it affordable to more investors. Many people would shy away from an INR 1000 stock but would consider an INR 500 one. Perhaps that’s still too expensive. The company could approve a 4-for-1 split and take the INR 1000 stock down to INR 250. Your 100 shares would become 400 shares, but would still be worth INR 100,000. People considering the stock might be more likely to buy at INR 250 than at INR 1000, even though they’re getting the same amount of ownership in the company for each rupee they invest. It’s a psychological thing, and who are we to question it?
Mathematically, stock splits are completely irrelevant to investors but they are often a sign of good things to come. A company usually won’t split its stock unless it’s optimistic about the future. Think about it. Would you cut your stock price in half or more if the market was about to do the same? Of course not. Headlines would declare the end of your fortunes and lawsuits might pile up. Stock splits tend to happen when a company has done well, driven up the price of its stock, expects to continue doing well, drops the price of its stock through a split, and expects to keep driving up the stock price after the split.
Stock splits were everyday occurrences in the 1990s bull market. IBM split twice, Oracle split five times, Microsoft split seven times, and Cisco split eight times. The stock didn’t just run straight up 90-fold, however. It made five 2-for-1 splits and two 3-for-2 splits along the way. It rose and split, rose and split, and so on. You can be sure that Microsoft wouldn’t have been splitting its stock if it wasn’t excited about its future.
Remember that a stock split drops the price of the stock. Lower prices tend to move quicker than higher prices. Also, the fluctuations of a lower-priced stock have a greater percentage impact on return than they do against higher-priced stocks. An INR 2 increase is a 4 percent gain for an INR 50 stock, but only a 2 percent gain for an INR 100 stock.
More important than all this, however, is that splits are downright fun. You’ll love it when your 100 shares become 200 and every INR 1 gain in price puts INR 200 in your pocket instead of the previous INR 100. You’ll feel like a real pro when revealing your performance to friends and need to toss in the phrase “split-adjusted” at the end.
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