How It Works
Let us say that Company A has recently announced a 3-for-1 stock split. Company A is currently trading at $300, has a market cap of $120 billion, and 400 million shares outstanding. To keep this example simple, let us say that Company A is still trading at $300 on the day it is supposed to split. That means that when it starts trading after its split, the company’s stock will be $100 per share, the market cap will still be $120 billion, and shares outstanding will now be 1.2 billion.
Investor A, a shareholder in Company A, currently holds 10 shares of the company, with a total value of $3000. After the split, Investor A will have 30 shares of Company A, with a total value that is still equal to $3000.
The key things that change in a stock split are the stock price of a company and the number of shares outstanding. In real life, when a stock split is implemented, the price of shares will automatically adjust, so you will not have to worry about doing much math.
Why a Company Does It
Stock splits do lead to greater liquidity for a company, which may be one of the key reasons a company does a stock split. Typically, stock splits are more for psychological reasons. A company’s board of directors may elect to do a stock split if they see the price of their stock as too high for the average retail investor.
Company A’s board of directors decided that their stock price was too high, so they agreed to a 3-for-1 stock. Even though the total value of the company will still be the same, the average retail investor will become more attracted to the stock because, after the split, it will be at a price that they will consider more affordable.
Stock splits assist in providing renewed interest in a company. With more people buying a company’s share after it has gone through a stock split, the total value of the company will increase due to the increase in demand. This effect on a company’s total value is usually temporary but can potentially go a long way depending on how successful the company has already been and their future expectations.