Why companies split stock?

Stock split or forward stock split is a corporate action where board of directors decides to issue more shares by dividing existing outstanding shares into multiple shares defined by the predetermined ratio. Most common ratios are 2 for 1 or 3 for one where investors for every share they own get two or three shares respectively. Likewise, price will be divided accordingly. If for example you originally owned 100 shares, each worth $15 in 2 for 2 split you will receive 200 shares each worth $7.5 and in situation where 3 for 1 split is done it will be 300 shares with $5 price per share. As you can see no real value is added and market capitalization is the same just like with reverse stock split.

Companies do this for various reasons. Some stock price can reach astonishing level and company’s official might want to lower the price to make it more appealing to small retail investors. Some argue that there is a psychological effect which makes owning more stock at a lower price more satisfying than owning a smaller number of shares with higher price. Stock exchanges have standardized number of shares as a trading unit and it is usually a 100 shares so it will be easier for small investor to buy one hundred shares at a lower price. Higher number of shares results in greater liquidity because of course there is a bigger float and popular trading price will almost certainly renew interest in the stock. This is shown through narrow bid – ask spread which reflect supply and demand for certain company’s shares. After stock split price decreases but it can be followed by an increase because of the interest of small investor who now perceive stock as more affordable and boost demand in that way.

Popular media service provider company Netflix has split stock twice since it started trading publicly in 2002. Company’s success has been followed by dramatic increase in price which company lowered by doing two for one stock split in 2004 leaving share price to $40. A little more than ten years later Netflix undergoes seven for one stock split lowering share price from $700 to $100. Other companies like Apple, Amazon and Berkshire Hathaway also undergone stock split mostly to expand shareholders base and make their stock more affordable to average investor.

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