Why Companies do Stock Split

A stock split can be defined as a method through which a company increases or decreases the number of shares it has in the market. After a split, the stock price will be reduced but the number of shares that are outstanding in the market will increase. Hence after stock split the total market capitalization of the company will be same, only the number of shares and price will be affected. There are many reasons due to which companies consider carrying out this corporate action of splitting the shares. Let’s look at some of them –

1. Many companies do stock split when the price of share has gone to a much higher level. Since as the price of a stock gets higher and higher, some investors may feel the price is too high for them to buy, or small investors may feel it is unaffordable. Splitting the stock brings the share price down to a more attractive level. A lower price change the mind of small investors, and they tend to buy the stock thinking that it is cheap, which in reality is not the case as the value of the share remain same after the stock split. Since value of a stock is affected by earnings of the company and not by stock split.

2. Another reason for splitting a stock is to increase a stock’s liquidity, which increases with the increase in number of outstanding shares. Since after stock split there are many more number of shares it imparts greater liquidity to the stock, as there will that much more number of shares to trade.

3. It also leads to better price discovery of the share of the company, because of more liquidity in the stock.

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