What are Stock Splits & Stock Merge ? How do They Work?

When a company adjusts the number of its outstanding shares, it may undertake a stock split or a reverse stock split, also known as a stock merger. These actions change the number of shares and their per-share price without altering the company’s overall market capitalisation or the value of an investor’s holdings. Below, we explain what stock splits and mergers are, why companies pursue them, and how they impact investors.

What is a Stock Split?

A stock split is a corporate action where a company increases the number of its outstanding shares by issuing additional shares to existing shareholders. Each share’s face value and price are proportionally reduced, but the total value of an investor’s holdings remains unchanged. Common split ratios include 2-for-1, 3-for-1, or 5-for-1, depending on the company’s goals.

For example, in a 2-for-1 stock split, a shareholder receives two shares for every one held, with each new share priced at half the original share’s value. If a company had 1 million shares at ₹100 each before the split, it would have 2 million shares at ₹50 each after the split. The company’s market capitalisation (₹10 crore) remains the same.

Why Do Companies Split Their Stocks?

Companies split their stocks for several reasons:

Increase Liquidity: A lower per-share price makes shares more affordable, increasing trading volume and market liquidity.

Broaden Investor Base: High share prices (e.g., ₹10,000) may deter retail investors. A split reduces the cost, making the stock accessible to more investors.

Signal Confidence: A stock split often signals management’s optimism about future growth, boosting investor sentiment.

Enhance Tradability: Lower-priced shares are easier to trade, especially for retail investors or those using fractional share platforms.

Does a Stock Split Change the Company’s Value?

No, a stock split does not alter the company’s market capitalisation or the value of an investor’s holdings. It redistributes the same equity into more shares. Unlike issuing new shares (which dilutes ownership), a stock split maintains the existing shareholders’ proportional value.

Example: Suppose a company has 1,000 shares at ₹1,000 each (total value: ₹10 lakh). After a 2-for-1 split, it issues 1,000 additional shares, resulting in 2,000 at ₹500 each. If you owned 100 shares worth ₹1 lakh before the split, you now own 200 shares worth ₹1 lakh.

How Does a Stock Split Benefit Investors?

While a stock split doesn’t increase the value of your investment, it offers benefits:

Improved Affordability: Lower share prices (e.g., ₹500 instead of ₹1,000) make it easier for retail investors to buy shares of high-value companies.

Increased Flexibility: More shares at a lower price allow for easier trading and portfolio adjustments.

Potential Price Appreciation: Post-split, stocks may see a temporary price increase due to higher demand from retail investors and positive market sentiment, though this depends on market conditions.

How Does a Stock Split Affect Stock Price?

A stock split reduces the per-share price proportionally to the split ratio. For example, in a 3-for-1 split, the share price drops to one-third of its original value. However, increased demand from retail investors, driven by the perception of a “cheaper” stock, can lead to short-term price appreciation. Psychologically, a lower price often makes the stock more attractive.

What is a Reverse Stock Split (Stock Merge)?

A reverse stock split (or stock merge) reduces the number of outstanding shares by consolidating them, proportionally increasing the per-share price. However, an investor's holdings' market capitalisation and total value remain unchanged.

For example, in a 1-for-2 reverse stock split, two shares are merged into one, doubling the share price. If you owned 100 shares at ₹50 each (₹5,000 total), you would own 50 shares at ₹100 each after the reverse split, still worth ₹5,000.

Why Do Companies Pursue Reverse Stock Splits?

Companies opt for reverse stock splits for several reasons:

Avoid Delisting: Stock exchanges like the BSE or NSE may have minimum share price requirements (e.g., ₹10). A reverse split boosts the share price to comply.

Improve Perception: Low share prices (e.g., ₹5) may signal financial distress or resemble penny stocks. A higher price can enhance the company’s image.

Attract Institutional Investors: Some funds avoid stocks below a specific price threshold. A reverse split makes the stock eligible for such investments.

Reduce Administrative Costs: Fewer shares lower the costs of managing shareholder records and compliance.

How Does a Reverse Stock Split Affect Investors?

A reverse stock split doesn’t change the value of your investment, but has implications:

Perception Risks: Reverse splits are often linked to struggling companies, which may lead to negative market sentiment and price declines.

Reduced Liquidity: Fewer shares can decrease trading volume, making it harder to buy or sell.

Fractional Shares: If the split results in fractional shares, brokers may cash them out, slightly altering your position.

Stock Splits, Reverse Splits, and Taxation

In India, neither stock splits nor reverse stock splits typically trigger a taxable event, as the total value of your holdings remains unchanged. However, when you sell the shares, capital gains tax applies based on your cost basis and holding period (long-term or short-term). Consult a tax professional for personalised advice.

Key Considerations for Investors

Stock Splits: These are generally positive, signalling growth and making shares more accessible. However, they don’t inherently increase your wealth.

Reverse Stock Splits: These may raise red flags, as they’re often associated with companies facing challenges. Evaluate the company’s fundamentals before investing.

Conclusion

Stock splits and reverse stock splits are strategic corporate actions that adjust the number of outstanding shares and their prices without affecting the overall market capitalisation or the value of investor’s holdings. While stock splits can enhance liquidity and accessibility for retail investors, reverse splits may signal underlying challenges, necessitating careful evaluation of a company's fundamentals before investing.