What is a stock split and how does it work?

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Nvidia will start trading today around 120$ after the 10:1 stock split. Let’s see what is a stock split and how it works.

In order to
increase the share’s liquidity and make it more affordable, a corporation may split its existing shares
into many shares, a move known as a stock split. Because the
split adds no actual value, even though the number of shares outstanding rises,
the shares‘ total dollar worth stays the same. In essence,
a stock split results in an increase in the company’s share count but also a corresponding decrease in share price.

How does it work?

  • Announcement:
    A stock split with a specified ratio (such as 2-for-1, 3-for-1, etc.) is
    announced by the corporation.
  • Change of
    Share Count: The split ratio is multiplied by each shareholder’s share count.
  • Share Price
    Adjustment: The split ratio is used to divide the market price of the shares.
  • Market
    Capitalization: Following the split, the company’s overall market
    capitalization stays the same.

Let’s see an example with Nvidia’s 10-for-1 stock split:

Pre-split

  • A
    shareholder has 100 shares.
  • A share costs $1200.
  • Shares
    total worth is equal to 100 shares * $1200, or $120,000.

After-split

  • A 10-for-1
    split is announced.
  • 10 shares
    are divided from each share.
  • Now, the
    shareholder has 1,000 shares.
  • One share
    now costs $120 (1200 / 10).
  • Shares
    total worth is equal to 1000 shares * $120, or $120,000.

What makes
the stock split historically positive?

Sign of
confidence:

Stock
splits are usually announced by companies after a major increase in share
price. This could be seen as an indication that the business is optimistic
about its chances for future growth.

Enhanced
liquidity:

The number
of outstanding shares rises when the stock is split, which may enhance
liquidity. More shares at a reduced price could draw in more investors, even
retail ones who might have been crowded out previously.

Perceived
bargain:

Reduced
share prices may increase demand by making the stock seem more accessible to
small investors. Investors may view a company priced at $50 as more affordable
than one priced at $200, despite the fact that the stock’s fundamental remains the same.

Psychology:

Historical
evidence shows that stocks often do well after a split, owing to increased
investor interest and psychological impact. This can result in a
self-fulfilling prophecy in which growing demand drives prices upward.

This article was written by Giuseppe Dellamotta at www.forexlive.com.

Go to Forexlive

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