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8.2.5 Stock Splits And Consolidations

Understand the basics and strategic importance of stock splits and reverse stock splits (consolidations) for publicly-traded companies. Learn how these actions can influence share prices and investor perception.

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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:

$$ \text{Price per share} \times \text{Number of shares} = \$100 \times 1,000 = \$100,000 $$

Post-split value:

$$ \text{Price per share} \times \text{Number of shares} = \$25 \times 4,000 = \$100,000 $$

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:

$$ \text{Price per share} \times \text{Number of shares} = \$0.25 \times 100 = \$25 $$

Post-consolidation value:

$$ \text{Price per share} \times \text{Number of shares} = \$2.50 \times 10 = \$25 $$

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

📚✨ Quiz Time! ✨📚

🧐 Assess and Solidify Your Understanding

Welcome to the Knowledge Checkpoint! You’ll find 10 carefully curated quizzes designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you’re on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

Good luck! 🍀💪

## What happens to the number of outstanding shares after a stock split? - [x] It increases - [ ] It decreases - [ ] It remains the same - [ ] It becomes zero > **Explanation:** With a stock split, the company issues more shares to current shareholders, thus increasing the number of outstanding shares. ## What is the typical primary motive for a company to use a stock split or reverse stock split? - [ ] To increase overall market capitalization - [ ] To pay off corporate debts - [x] To make the company’s share price more affordable for investors - [ ] To reduce the company’s equity > **Explanation:** The primary motive for using a stock split or reverse stock split is to make the company’s share price more affordable for investors. ## During a four-for-one stock split, if you originally owned 1,000 shares, how many shares would you own after the split? - [ ] 1,000 shares - [ ] 3,000 shares - [ ] 2,000 shares - [x] 4,000 shares > **Explanation:** In a four-for-one stock split, three additional shares are issued for each share held, so owning 1,000 shares before the split would result in owning 4,000 shares after the split. ## How does the market price of shares change after a stock split? - [ ] It increases - [x] It decreases - [ ] It remains the same - [ ] It becomes zero > **Explanation:** After a stock split, the market price of the shares decreases as the number of shares outstanding increases. ## What remains unchanged after a stock split? - [x] The investment value of shareholder holdings - [ ] The number of outstanding shares - [ ] The price of individual shares - [ ] The number of shares issued > **Explanation:** The investment value of a shareholder's holdings remains unchanged after a stock split. ## In the event of a reverse stock split, how are a shareholder’s total shareholdings affected? - [ ] They increase - [x] They decrease - [ ] They remain the same - [ ] They double > **Explanation:** In a reverse stock split, each shareholder’s total shareholdings in the company are reduced accordingly. ## If a company executes a reverse split of one new share for 10 old shares and you owned 100 shares before the split, how many shares would you own after? - [ ] 100 shares - [ ] 50 shares - [x] 10 shares - [ ] 1 share > **Explanation:** In a one-for-ten reverse split, the number of shares held by a shareholder would be divided by ten, so owning 100 shares before the split would result in 10 shares after. ## What often prompts companies to perform a reverse stock split? - [ ] Excessively high market price - [ ] Increase in overall market demand - [ ] Requirement to reduce shares to zero - [x] The need to raise the market price of shares that have fallen significantly > **Explanation:** Companies often perform a reverse stock split to raise the market price of shares that have fallen significantly and to avoid delisting by a stock exchange. ## During a stock split, what happens to the equity section of the company’s statement of financial position? - [ ] It increases - [ ] It decreases - [ ] It changes structure - [x] It remains unchanged > **Explanation:** The equity section of the statement of financial position remains unchanged because the stock split only affects the number of shares but not the total equity. ## Why might a reverse stock split be viewed positively by potential investors? - [ ] It decreases the number of shares they own - [ ] It implies high future dividends - [x] It can lead to a more attractive share price and potentially raise new capital for the company - [ ] It guarantees immediate profit > **Explanation:** A reverse stock split can lead to a more attractive share price and puts the company in a better position to raise new capital, which might be viewed positively by potential investors.

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Saturday, July 13, 2024