A stock split is a great way to increase investor interest in a stock. A stock split does not change the value of a company, but spreads that value over more shares. However, splitting has its drawbacks.
The total market capitalization remains unchanged, but the stock split lowers the price of each stock. Therefore, by splitting the share price, the company may be able to get price-sensitive investors to buy the stock.
A stock split also increases the liquidity of the stock. This is because the company will issue more shares once the split takes effect. If you split XYZ stock 1 for 2, then after the split, 200 shares of XYZ stock will replace his 100 shares of XYZ stock, half the original stock price.
Stock splits can lead to strong price volatility in the short term and even before the split, as falling stock prices increase investor interest and increase liquidity.
for example, Amazon.co.jp (AMZN) executed a 1-for-20 split on June 6, 2022. The stock traded above his 5% mark on March 10 on strong trading, shortly after the split was announced. The rally boosted the stock by more than 25%, reaching an all-time high in August.
excessive stock splits
But too many stock splits are not good. IBD founder William O’Neill has warned that a split could work both ways. However, sellers can also use this as an opportunity to pitch in the upside of the stock split.
Also, stock splits are usually executed after the stock has gone up significantly. As a result, short sellers may see it as an opportunity to short the stock in splits. Even for split stocks, the price goes down when the short sale gets bigger. This is especially true when the stock has split many times, attracting sellers and putting pressure on the stock.
NVIDIA(NVDA)’s 2006 and 2007 stock splits are a good example.
The company went through a 2-for-1 split on April 7, 2006. After the split, the stock price fell to a low in July and then rose again. On September 11, 2007, his second split of 1-3 came after a strong breakout from the base of the Cup with Handles.
The stock tried to keep rising but failed and dropped to a low in November 2008.
Market conditions also affect the outcome of stock splits. “It may not be wise for a company whose share price has been on the rise for a year or two to declare an extravagant split near the end of a bull market or in the early stages of a bear market,” O’Neill said.
This is because strong short selling can quickly pull down stocks that have surged or are already being pulled by a larger market downtrend.
A reverse stock split is the exchange of more shares for fewer shares. Again, the market cap and value of the company remains the same. However, by reducing the number of outstanding shares, the company makes the shares less liquid and more expensive.
This strategy is common when a company wants to list its shares on an exchange or is trying to avoid delisting. While stock splits are often a sign of strength, reverse splits indicate potential potential problems such as delisting risk.
Follow VR Ramakrishnan @IBD_VRamakrishnan For more information on investing.
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