EXPLAINED: A stock split helps increase liquidity in a stock by making it more affordable for retail investors, but does not guarantee an uptick

• Tata Steel will be splitting its stock in a 10-for-1 ratio this coming Friday.
• The stock split would help Tata Steel by increasing liquidity as it becomes affordable for investors.
• A stock split does not change anything about the stock’s fundamentals, it just makes it look cheaper.

It is a season of stock splits as big and small corporations are actively increasing the supply of shares by splitting them. Tata Steel on July 26 said that it had gotten the necessary approvals for the sub-division of its shares in the ratio of 10-for-1.

This means that shareholders will get 10 shares for every single share of the Tata Group’s steel business. Bajaj Finserv’s stock rallied on July 27 on news that the company was contemplating a stock split along with a bonus issue.

If a company is splitting its stock, then why should the price change? Business Insider India explains all you need to know about stock splits.

What is a stock split and what does it mean for Tata Steel investors?

When a listed company increases the number of outstanding shares by issuing more shares to the existing shareholders, it is said to have split its existing shares so that there are more shares available in the hands of investors. The stock split does decrease the market price of the individual shares in proportion to the split ratio, but does not cause any change to the market capitalization of the company.

Investors of Tata Steel will get 10 shares instead of one share, the cost of each new share would be one-tenth the cost of the original share. For instance, the shares of Tata Steel is currently trading at roughly around ₹950. After the split, an investor would get 10 shares with each of them priced at ₹95. This is just an example, the actual stock price would depend on the share price of that day.

Motilal Oswal explains that the split shares neither add new value nor does it dilute the ownership stake of the shareholders. However, they do increase the number of shares an investor holds.

“Imagine a company. It has issued around 1,00,000 equity shares of face value of ₹10 per share. The company decides to split its shares in the ratio of 2:1. What this essentially means is that every share of the company will now be split into two. This will, in effect, increase the number of equity shares of the company to 2,00,000 from the erstwhile 1,00,000. And simultaneously, the face value of the shares would also come down to ₹5 per share,” the brokerage firm said.

Why is Tata Steel doing a stock split?

The stock split would help Tata Steel by increasing liquidity as the shares become much cheaper for small retail investors and attracts high trading volume, Manoj Dalmia, founder and director of Proficient Equities, told Business Insider.

“Another one of the main stock split benefits is that the shares of a company generally see increased liquidity. Since shares have now become more accessible to retail investors, more people would show increased demand for it, which can increase liquidity in the counter. Buying and selling shares will be far easier after a stock split,” Motilal Oswal said.

Tata Steel’s shares were trading at ₹953 at 11:17 am on Tuesday morning, after witnessing a dip of 16.6% year-to-date.

What companies have undergone a stock split?

Multiple Indian companies — including Johnson Pharma, JBM Auto, Jubilant Food — have undergone a stock split this year. Internationally, Alphabet Inc-owned Google and Jeff Bezos’ ecommerce giant Amazon splits their stock in a 20-for-1 ratio.

Rajnish Wellness, Ontic Finserve, Hindustan Foods and Shanti Educational Initiatives carried out a stock split last Friday on July 22, 2022. High Energy Batteries (India) would be next in line to carry out a stock split in the month of August.

What does a stock split mean for the investors?

A stock split does not change anything about the stock’s fundamentals. A way to look at it is that the actual size of the company stays the same but the shares issued increases, leading to a reduction in price of each share.

For instance, a group of four friends slice a pizza into four pieces. Each of these friends would get one slice. However, if the same pizza is split into eight pieces, everyone would get two slices. The size of the pizza would be the same, however, the shares coming out of it would increase.

Companies — including Tata Steel, Johnson Pharma, Google, Amazon — carry out such stock splits to make the share more affordable for retail investors, making the stock more liquid.

“This will make a shareholder have more shares in the company at a cheaper price making these shares more affordable for both existing and new investors,” Dalmia noted.

“In a stock split, investors who own stocks still have the same amount of money invested, but now they own more shares at a proportionately lower price. But as we saw above the value may not exactly be the same and normally, the stock split tends to make the stock more valuable due to its wider reach. That is normally one of the most popular reasons for companies to do a stock split,” according to financial services company IIFL.

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