Stock splits and reverse stock splits, strategic financial manoeuvres, are tools companies use to adjust the number of their outstanding shares without changing the total value of the shares held by investors. These actions, when strategically implemented, can have significant implications for investors and the company’s stock performance. NMTBP delves into these splits, why companies undertake them, and their impact on shareholders

What Is a Stock Split?

A stock split happens when a company increases the number of its shares to boost its liquidity. Although the number of shares outstanding increases by a specific multiple, the total value of all shares outstanding remains the same because a split does not fundamentally change the company’s value

The most common split ratios are 2-for-1 or 3-for-1 (sometimes denoted as 2:1 or 3:1). This means for every share held before the split, each shareholder will have two or three shares, respectively, after the split

Example:

• Before split: An investor holds 100 shares at £100 each (total value = £10,000)
• After 2-for-1 split: The investor holds 200 shares at £50 each (total value = £10,000)

Reasons for Stock Splits

Increase liquidity: Lower prices make the share more affordable to a broader range of investors, potentially increasing trading volume and liquidity. NVIDIA, for example, gave a reason for its forward stock split announced on May 22, 2024: the wish “to make stock ownership more accessible to employees and investors”

Perception of growth: A stock split can signal that the company is confident about its future growth, as splits often occur when stock prices have risen significantly

Index inclusion: Companies with lower share prices might find it easier to be included in certain stock indices with share price limits

Impact on shareholders:

Psychological effect: Shareholders might perceive the split as a positive signal of company growth

No change in value: The overall value of an investor’s holdings remains the same immediately after the split

Increased accessibility: More investors can afford to buy shares, potentially increasing demand

Reverse Stock Splits

A reverse stock split reduces the number of a company’s outstanding shares by consolidating existing shares into fewer, more valuable shares. Common reverse split ratios include 1-for-2, 1-for-5, or 1-for-10. In a 1-for-5 reverse split, every five existing shares are consolidated into one new share

Example:

• Before reverse split: An investor holds 500 shares at £2 each (total value = £1,000)
• After 1-for-5 reverse split: The investor holds 100 shares at £10 each (total value = £1,000)

Reasons for Reverse Stock Splits:

Compliance with listing requirements: Companies facing delisting from stock exchanges due to low share prices can use reverse splits to boost share prices above the minimum required threshold

Improved perception: Higher share prices can enhance the company’s image and attract institutional investors who might avoid low-priced shares

Reduce volatility: With fewer shares outstanding, reverse splits can help reduce price volatility and speculative trading

Impact on Shareholders:

Psychological effect: Reverse splits can be perceived negatively as they often signal that a company is struggling with low share prices

No change in value: The total value of an investor’s holdings remains the same immediately after the reverse split

Potential for reduced liquidity: Higher share prices might limit the stock’s accessibility to small investors, potentially reducing liquidity

Strategic Considerations

Both stock splits and reverse stock splits are strategic decisions based on the company’s objectives and market conditions. While stock splits are generally viewed positively, suggesting growth and confidence, reverse stock splits can carry a stigma of financial distress. However, in both cases, the company’s underlying fundamentals remain unchanged by the split itself

Stock splits and reverse stock splits are important tools companies use to manage their stock prices and market perceptions. Understanding these manoeuvres is crucial for investors as they directly impact share quantity and price without altering the total value of holdings. Being informed about the reasons behind these splits can help you make better decisions and interpret the potential implications for your portfolios