8.2.5 Stock Splits And Consolidations

Stock Splits And Consolidations

At any given time, a publicly-traded company has a set number of outstanding shares trading in the market. As part of their corporate strategy, the company’s board of directors may decide to alter this number using a stock split or a reverse stock split (consolidation).

Most companies aim to keep their shares trading within a specific price range, typically between $10 and $20, aligning with the price levels of similar companies in their sector. The primary motive for using stock splits or reverse splits is to align the company’s share price with their target range, making shares more affordable and potentially attractive to a wider range of investors.

Stock Splits

A stock split increases the number of shares outstanding by issuing more shares to current shareholders. Consequently, the stock price is reduced because there are more shares in circulation.

Example

In a four-for-one split, three additional shares are given for each share held by a shareholder. If you owned 1,000 shares before the split, you would own 4,000 shares after. If the market price of the shares was $100 before the split, it would be approximately $25 after the split.

Here’s a breakdown:

Pre-split value:

Post-split value:

Key points include:

• The overall investment value of your holdings remains unchanged.
• While the equity per share is reduced, the equity section of the company’s financial statement remains unchanged.

Reverse Stock Splits (Consolidations)

When the market price of shares is too low, a reverse stock split helps increase it. The consolidated shares reflect a higher price per share, and each shareholder’s total holdings decrease proportionally.

Example

“If a one new share for 10 old shares reverse split is executed, a shareholder owning 100 shares will now own 10 shares. If the shares were trading at $0.25 before the reverse split, the new shares would be worth about $2.50 each.”

Here’s the math:

Pre-consolidation value:

Post-consolidation value:

Key takeaways about reverse splits:

• Often used when a company’s shares fall to levels unattractive to investors with large capital.
• Used to avoid delisting from stock exchanges by meeting minimum share price requirements.
• Improves a company’s position to raise new capital.

Key Takeaways

• Stock Splits increase the number of shares, making individual shares more affordable but do not change the overall value of ownership.
• Reverse Stock Splits decrease the number of shares to increase the individual share price, helping stabilize the market value of a company’s shares and prevent delisting.
• Both actions aim to realign share price with market expectations without changing the overall value from the shareholder’s perspective.

Glossary

• Outstanding Shares: Total shares of a company that are currently held by all its shareholders, including shares held by institutional investors and restricted shares owned by the company’s officers and insiders.
• Stock Split: An action taken by a company to divide its existing shares into multiple shares, increasing the number of shares outstanding and reducing the share price proportionally.
• Reverse Stock Split: An action taken by a company to reduce the number of its outstanding shares, increasing the share price proportionally.
• Equity: The value of the shares issued by a company.
• Shareholder: An individual or institutional investor that owns shares of a company.

Frequently Asked Questions (FAQs)

Why do companies perform stock splits?

Companies conduct stock splits to make their shares more affordable for investors, increasing liquidity and marketability.

Do stock splits increase the value of my investment?

No, stock splits do not change the overall value of your investment. They change the number of shares you own and the price per share proportionally.

Why do companies perform reverse stock splits?

Companies carry out reverse stock splits to increase their share price, make their shares more appealing to investors, and maintain stock exchange listing standards.

Will a reverse stock split affect my ownership percentage?

No, a reverse stock split does not alter your ownership percentage in the company—it changes only the number and price of your shares.

Chart: Stock Split and Reverse Stock Split Example

    pie showData
	    title Stock Split (4:1) and Reverse Stock Split (1:10)
	    "Pre-split Shares": 1000
	    "Post-split Shares":  4000
	    "Old Shares (Reverse Split)": 100
	    "New Shares (Post Reverse Split)": 10