What is a stock split?

A stock split, also known as a stock division or stock divide, is a corporate action in which a company increases the number of its outstanding shares while reducing the price of each share proportionally. In a stock split, the total market capitalization of the company and the ownership percentage of existing shareholders remain unchanged. Stock splits are generally carried out to make a company's shares more affordable for investors or to increase liquidity in the stock.

Stock splits are typically expressed in a ratio format, such as 2-for-1, 3-for-2, or 5-for-1. Here's what these ratios mean:

1. 2-for-1 Stock Split: In a 2-for-1 stock split, for every one share an investor currently holds, they receive two shares after the split. The share price is halved.

2. 3-for-2 Stock Split: In a 3-for-2 stock split, for every two shares an investor currently holds, they receive three shares after the split. The share price is adjusted accordingly.

3. 5-for-1 Stock Split: In a 5-for-1 stock split, for every one share an investor currently holds, they receive five shares after the split. The share price is divided by five.

The key points to understand about stock splits are as follows:

1. Proportional Adjustment: Stock splits are typically implemented to maintain the proportional ownership and market capitalization of the company. The total value of the shares before the split equals the total value of the shares after the split.

2. Share Price Adjustment: The most noticeable effect of a stock split is the reduction in the stock's price per share. For example, if a stock was trading at $100 per share and underwent a 2-for-1 split, the post-split price would be $50 per share.

3. No Change in Value: While the number of shares held by investors increases, the overall value of their investment remains the same. For instance, if an investor had 100 shares valued at $100 each before a 2-for-1 split, they would have 200 shares valued at $50 each after the split, resulting in the same total investment value.

4. Increased Liquidity: Stock splits can make shares more affordable for a broader range of investors, potentially increasing liquidity and trading activity.

5. Psychological Impact: Some companies choose to implement stock splits to make their shares appear more accessible to retail investors and to potentially boost investor confidence.

6. Not All Companies Split: While some companies split their stock to achieve the above objectives, others may never split their stock or may not do so for an extended period, regardless of the share price.

It's important to note that stock splits do not fundamentally change the financial health or prospects of a company. They are purely a corporate action aimed at adjusting the number of shares and their price to make them more accessible or improve trading activity. Investors should also be aware that stock splits can result in adjustments to options contracts and derivatives tied to the company's stock.

Investors should consider a company's financial fundamentals, growth prospects, and other factors in addition to stock splits when making investment decisions.