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Stock Splits and Reverse Stock Splits: what are they and what are they used for

Stock Splits and Reverse Stock Splits: what are they and what are they used for

Stock splits and reverse stock splits are financial transactions companies carry out aiming at influencing on the negotiations of their shares and liquid funds. This post explains what they are and what they are used for.

6 april 2016

Within the business environment, a stock split is a finance operation through which companies multiply the value of their share and divide their nominal value. For example, an investor owns 10 shares with a €400 value, after a 2:1 stock split, he will have 20 actions with a €200 nominal value. Hence, the investor holds the same assets.

Why would a company or an investor be interested in unfolding their shares? To rise the share’s value of contracting and liquidity. Incrementing the splitting of the shares, the shareholder will own more shares with a lower nominal value, favoring, hence, the transactions. Additionally, low prices rise liquidity.

Stock splits also have a psychological effect on the little investor, who tends to acquire cheaper shares in order to be able to buy a higher number of titles.

In Ciberconta, they distinguish five stages in the execution of a stock split:

  1. Candidacy

The company has not officialised the stock split yet, but there are rumours on its possible execution.

  1. Announcement

The entity announces the stock split and investors acquire shares because they think that in the future they will rise in value.

  1. Post-announcement

The share depreciates because it has lost interest.

  1. Pre-stock split

Phase previous to the stock split, when the share regains its interest. It is very probable for the action to revalue until the day previous to the stock split.

  1. Post-stock split

The price of the share is corrected and its value decreases.

Stock splits favour transactions and rise liquidity

An easy way of understanding what is and what is a share unfolding used for is to analyse the case of Apple. The American multinational executed a 7:1 stock split in June 2014, multiplying by 7 the number of shares. As a consequence, each share reduced its value from $645 to a little over $93, a more accessible price for the little investor.

Reverse stock split

The opposite of stock splits are reverse stock splits, which consist on grouping shares to multiply their nominal value.  A company can make a reverse stock split when concentrating a 10-€1-shares pack and float on the Stock Market as a single €10-share. This is a usual strategy among small-capitalization companies.

There are several examples of reverse stock splits. The Banco Popular carried out a title grouping in June 2013 with a 1:5 relation. After this financing operation, the share went over 2,8 euros.

Below you can see a graphic on the company’s evolution since they widened their capital in November 2012 until the reverse stock split took place in June 2013.

Image source: eleconomista.es

More information: https://www.caixabank.com/deployedfiles/caixabank/Estaticos/PDFs/AprendaConCaixaBank/aula760.pdf

 
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