When a company is concerned that its share price is pricey and wants to make the shares affordable, the corporate action it opts for is a Stock Split/Subdivision of shares. A stock split helps companies to appeal to new investors without any addition to the market cap. Let us see how a stock split works and how it impacts investors.
What is a stock split?
A stock split is when a company issues more shares to its current shareholders by lowering the face value of each share at a specified ratio. It means that the number of outstanding shares is increased by dividing the existing shares originally issued to the present shareholders. Though there is an increase in the number of shares, the overall market capitalization of the company and the value of each shareholder’s stake remain the same.
As mentioned above, the stock split happens in a specified ratio. For example, if the ratio is 1:5, it means that for every one share held the shareholder will get 5 shares respectively.
Let us see illustrations in the below table to find the changes in the number of shares, share price and the face value of the share before and after the split for different ratios
|
Before Split |
After Split |
|||||||
| Stock split | No. of shares held | Share Price | Face Value | Value of Investment | No. of shares held | Share Price | Face Value | Value of Investment |
| 1:2 | 10 | 900 | 10 | 9000 | 20 | 450 | 5 | 9000 |
| 1:5 | 10 | 900 | 10 | 9000 | 50 | 180 | 2 | 9000 |
Remember that in a stock split, the face value of the share decreases by the ratio of the split.
How does a stock split affect you?
If you are an existing shareholder, a stock split may appear to have no noticeable effect but it eases your portfolio management and provides more liquidity with an increase in the number of shares
If you are not a shareholder of the company that went for a stock split, you have an opportunity to buy the shares now at a lower price than before.
For example, if IRCTC’s share price was at ₹ 4500. After a stock split in the ratio of 1:5 in Oct-22, the share price of IRCTC would become ₹900 making it affordable for new investors and giving the existing shareholders flexibility to manage their portfolios.
Key dates in a stock split
Record date is the date on which the company checks its records to identify the eligible shareholders for a stock split.
Ex- split date– is the date on which the stock starts trading at the new adjusted split price.
The sub-divided shares will be credited with the new ISIN to the existing shareholders on the immediate next trading day after the record date.
Adjustment of Future & Options contract due to a stock split
After the stock split, the market lot and strike price for F&O contracts with the stock as underlying security will be revised by calculating the adjustment factor.
Adjustment factor for Stock split of A: B is defined as (B/A). In the case of a stock split ratio of 1:5, the adjustment factor is (5/1) = 5.
1. Futures/Strike Price: The adjusted futures/strike price will be arrived at by dividing the old futures/strike price by the adjustment factor.
2. Market Lot: The adjusted market lot will be arrived at by multiplying the old market lot with the adjustment factor
Let us consider the example of Jubliant Food Works that went for a stock split in the ratio of 1:5 in April 2022.
Before Adjustment:
| Instrument | Security Symbol | Expiry Date | Strike Price (₹) | Option Type | Long Position | Short Position |
| OPTSTK | JUBLFOOD | 28-Apr-22 | 2750 | PE | 0 | 125 |
| OPTSTK | JUBLFOOD | 28-Apr-22 | 2750 | CE | 125 | 0 |
After Adjustment:
| Instrument | Security Symbol | Expiry Date | Strike Price (₹) | Option Type | Long Position | Short Position |
| OPTSTK | JUBLFOOD | 28-Apr-22 | 550 | PE | 0 | 625 |
| OPTSTK | JUBLFOOD | 28-Apr-22 | 550 | CE | 625 | 0 |
Remember that the investment value/ contract value of a future or options contract remains same after adjustment, due to a stock split.
What is Reverse Stock Split?
A reverse stock split is when a company reduces the number of outstanding shares by increasing the face value of the share, without diluting the market cap. As in a stock split, the value of investment of the shareholder remains unaffected by a reverse stock split.
Let us see an example of how reverse stock split works
Say, you hold 10 shares of a company XYZ at a share price of ₹ 50. The total value of your investment in XYZ becomes ₹ 500.
The company XYZ goes for reverse stock split in the ratio of 2:1. After the reverse stock split, you will now hold only 5 shares of XYZ. But the value of each share will now increase to ₹100, keeping your total investment at ₹ 500 like before.
It is important to remember that a stock split makes a share affordable to new investors and provides flexibility to existing shareholders with a decrease in share price and an increase in the number of shares respectively. If you are watching a particular stock and if it goes for a split, it may provide you an opportunity to buy that stock at a lower price than before. The other corporate action in which the number of outstanding shares of a company increase is the Bonus Issue. Click here to know the differences between bonus shares and stock splits.
Disclaimer: This blog is exclusively for educational purposes.
