Debt Dictionary

Stock Split

Investment Dictionary -> Stock Split

Let us say that for years one has been holding a stock that steadily increases in market value. Then, the person receives a letter from the company in which he owns some stock. The firm announces to its shareholders that there will be a stock split. As a shareholder what will this mean to the person?

There will be no reason to panic or celebrate. If one owns a hundred shares of stock X at $50 per share, the market value of the stock he owns will be $50. Let us say that a two-for-one split is announced by the company. The result will be that one will own twice as many shares which are priced at $25 per share. The total value of the shares will still be at $5000. The person did not lose or made a dollar and his holdings value stays the same.

The decision for a split may result for a number of reasons. It is often the case that the price of stock has risen significantly over quite some time, usually years. The stock attractiveness, as a result, may have begun to decline. The price has skyrocketed, although the value of the stock is also higher.

On the other hand, a reverse stock split may be initiated by the company when the latter decides that it is trading its stock at a low value. The perception of the investors may be that their stock has become too cheap. Therefore, trade at a low dollar value may come for a reason. In some cases, when the stock is below $3 in value per share, investment firms and investors find it unattractive. To answer such perceptions, the companies may decide to execute a reverse stock split. Let us say that stock X trades on a stock exchange at $2.5 per share and one holds 100 shares with a total value of $250. Then, the company decides to make a two-to-one reverse stock split. One will end up owning only 50 shares of stock X that are priced at $5 per share.

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