MOMO stands for momentum, which, in the world of finance, reflects the aggressiveness of the
Stock splits, or share splits, have been growing in popularity over the past two decades. Just last year, we saw the stock splits of giants like Tesla and Apple. At first, many people find stock splits alarming as they think that it relates to sharing dilution; however, that isn’t true. Stock splits mean that the company divides its existing stock into multiple shares, which reduces the price of each share but not the market capitalization of the company. Let’s take a look at the example below to.
Let’s say that you have a $100 dollar bill, and you want to split it. You go and exchange the $100 bill for 5 $20 bills or 2 $50 bills. Now, the value that you hold in your possession is no different than it was before. You’ve merely split the value into different denominations. The same concept applies to stock splits.
When the stock of a company becomes too expensive, the board of directors may choose to execute a stock split. By doing that, they would increase the number of outstanding shares, thereby reducing the price of each share and making it more attractive to investors.
What about the existing shareholders?
Depending on how the stock is split, each shareholder gets an additional number of shares. For example, in a 2-for-1 split, the existing shareholder would get an additional share, making him the owner of 2 shares. But the price of each of the shares (existing and incoming) are both slashed in half, meaning that his two shares are now equal to the original value of one share before the split.
Essentially the existing shareholders are not adversely affected by a stock split. In fact, stock splits are designed to be advantageous for everyone. If the price of each share is reduced, then more people can afford to buy the stock, which will drive the price of the stock upwards.
Apple executed a 4-for-1 stock split reducing the price of its shares from $460 to roughly $115. On the other hand, Tesla executed a 5-for-1 split bringing the share price down to $375 from the whopping $1,875 that it was before. Both stocks surged after the announcement of the stock split.
Why do investors love stock split?
There are plenty of people who do not see the advantages that come with stock splits, and they aren’t entirely wrong. At face value, a stock split has no fundamental effect on the investors, good or bad.
However, there are plenty of people who view stock splits as an indicator that the company’s stock price is high and, therefore the company is doing well. Furthermore, stock splitting allows a company to increase its stock’s liquidity. Stocks that trade at higher prices often come with high bid/ask spreads, potentially making them less favourable.
The Bottom Line
Stock splits have a significant effect on the psychology of the investors. If you already have the stock and it just doubled, it makes you happy even if the value hasn’t changed. A stock split has no effect on the company’s market cap; therefore, nothing changes. However, splits do generate additional liquidity, which drives demand, and in turn, the stock price.
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