A very recent fiasco within the stock market that was to do with GameStop shares and Hedge fund, forced many people to look up ‘how the stock market works in order to understand what was going on and why Wall Street was coming to a halt because of some Reddit users. These types of unforeseen situations lead us to think many people do not know about the very basic rules and workings of the stock market, such as why do stocks split, how do brokerage accounts work, and the minimum age when you can buy stocks, etc.
Not everyone has to be a pro at everything, different people have different interests and thus end up learning more about their respective interests. But if you are a person who is into investment through stocks and earning to accumulate wealth, you need to learn about the stock market and how it operates. Starting with stock splitting, the reason and how it works all depends upon the company.
Just by how the phenomenon is worded, splitting something doesn’t sound beneficial to you, especially when investments and earnings are involved. But the splitting of stocks is more complex than about anything in the stock market is. Let’s look at the process in terms of commonly asked questions:
What is a stock split?
Essentially, a stock split is the company’s way to make its shares more accessible for smaller investors. Usually, this makes more sense when a particular stock price has risen considerably over time and a split would help balance out its outstanding shares against the share price.
Understanding the workings of a stock split is not difficult. Let’s say a company has a 4-for-1 stock split where the stock before the split was priced at $100, the price for the stock after the split would come to $25 each. Meaning initially each stock cost a hundred dollars but now it’s for $25 through a 4-way split. The whole phenomenon doesn’t necessarily benefit the investors by making them richer than before, because a stock split does not affect the market capitalization of a company. Only the share price per stock decreases when the number of shares increases.
The general response of investors regarding stock splits is positive because it shows that the company is trying to make the stocks more attainable to a larger audience of investors. Since the stocks appreciate because the number of buyers increases, your investment portfolio looks better as well.
Is stock split good or bad?
Companies split their stocks to diversify their investor base and it doesn’t benefit either the company or investors monetarily. The principle remains the same no matter the split ratio, the price of the share gets divided by the number of splits in a stock.
The price per stock decreases when you divide one stock into x number, so you earn the same according to your ownership of the stocks.
It only improves your investment portfolio by showcasing the company you have invested in to be doing good when the number of shares increases. So it’s neither good nor bad.
What is a reverse stock split?
A reverse stock split is quite another story from a stock split. It is when a company divides the number of shares its investors are holding by a certain amount, falsely raising their share prices. This is not authentic price appreciation because it is not a result of the company’s achievements or growth.
A 1-for-2 reverse stock split indicates that if you previously owned 20 shares in a company for $10 each, those figures will change into you owning 10 shares in the company that now all amount to $20 each. There is no active benefit of a reverse stock split. Usually, a company resorts to it to make sure they don’t lose their listings in major exchanges. A reverse stock split helps increase the price per share for companies so that they don’t get delisted on their preferred stock exchange, where there’s a cap for a minimum price for each stock in order for companies to make it to the listing.
Is it better to buy a stock before or after a split?
This is a question best answered by mentioning that the capacity of your investment really tells whether you could benefit from a stock split or not. If you are a small investor, a big company imposing stock splits on their shares would mean that you might be able to invest in a big company, which would previously not be possible considering bigger companies have a very high price per share.
As a moderate to high volume investor, it does not directly impact your earnings, investing before or after a stock split. The investment amount and earnings remain the same. Your portfolio might improve but overall, there’s hardly any difference for the big investors. Therefore, it’s a good thing for smaller investors, because some big stocks become attainable but bigger investors don’t get much affected by it.