Finance

Stock Split and Stock Consolidation

Stock Split and Stock Consolidation

What is a Stock Split?

A stock split is a process of dividing the stock into multiple shares to boost the liquidity of the shares in the market. In this process though the number of shares increases, the value of the share remains the same as before the splitting.

The most common ratios in which stocks are divided are 2:1 or 3:1 meaning two shares for every one share or three shares for every one share hold earlier. Stock split can also be expressed in percentage terms. Thus, a 2 for 1 (2:1) split can also be termed a stock split of 100% and 3 for 2 splits (3:2) split can also be termed a stock split of 100%.

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Why do companies split the stocks?

Companies often split their stocks when they believe the price of their stock exceeds the amount smaller individual investors would be willing to pay for the stock. By reducing the price of the stock’s investors would be willing to pay for the stock as the stocks now become more affordable to them. An increase in liquidity and the bid-ask spread of the stock are attained by the help of stock split.

Effect of Stock Split

A stock split does not have any effect on the balance sheet figures only the number and amount per share varies and the amount of share capital remains the same. So only the value per share is to be reduced and the number of shares outstanding needs to be increased in the financial statements of the company post stock split.

The prices are adjusted on the same day when the stock split action is implemented. A stock split does not affect a company’s equity or its market capitalization. Only the number of shares outstanding in the market change, so a stock split does not directly change the value of the net assets of a company.

For example, when a company announces a 2-for-1 (2:1) stock split then it will distribute one additional share for each outstanding share. So, suppose an investor had 100 shares of XYZ company at price $200 each(total value $20,000= 100*200) then post-split, the same investor will now hold 200 shares for price $100 each(total value $20,000= 200*100).As you can see the stock prices are halved whereas the number of stocks has been doubled.

What is Stock Consolidation?

In simple terms, we can say that it is completely opposite to that of Stock Split and hence can also be called as a reverse stock split. It is the reduction in the number of outstanding shares which in turn increases the price of the share. A stock consolidation is also a signal that shows the company in distress.

The most common ratios in which stocks are divided are 1:2 or 1:10 reverse split, meaning that for two shares owned earlier a shareholder will receive one share of the company’s new stock.

Why does the company consolidate the stocks?

A company performs stock consolidation in order to increase or boost its stock price. Stock consolidation helps in improving the share price and can be used in order to maintain the brand image of the company. For the company to remain listed on exchanges there is some minimum share price requirement and if the share price is reduced below the minimum requirement then there is a possibility for its delisting. Stock consolidation also helps to maintain the share price after a spinoff.

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Effect of Stock Consolidation

A reverse stock split does not increase the market capitalization of a company – although the number of shares outstanding decreases, the stock price is adjusted accordingly in that the market capitalization of the company remains unchanged. In other words, shareholder value is unaffected by a reverse stock split.

Consider an example, Mr. Ramesh an investor currently owns 100 shares of ABC company at $100 each (total value $10,000 =100*100). The company now announces the stock consolidation of 1:10, thus now post the reverse split the same investor will now hold 10 shares for the price of $1000 each (total value $10,000= 10*1000). Thus, the total value of investors share remains unchanged.

 

Author: Trushali Hindocha

About the Author:

Trushali completed her graduation in Computer science and engineering, she has worked as Associate Consultant in Atos Syntel for 18 months. She is currently pursuing MMS in Finance from KJ Somaiya Institute of Management Studies and Research, Mumbai. She is also well acquainted with Tableau and programming languages like Python and R for Data Analytics.

 

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