A stock split is a corporate action in which a company divides its existing shares into multiple shares to lower the trading price of its stock, making it more accessible to a larger number of investors. Though the value of a shareholder’s total investment remains the same after a stock split, the number of shares they own increases. In simpler terms, a stock split gives investors more shares but doesn’t change the value of their investment in monetary terms.

In this article, CA Manish Mishra will explore what a stock split is, how it works, and its legal implications under Indian law.

How Does a Stock Split Work?

A stock split involves the division of each existing share into a certain number of new shares. For example, in a 2-for-1 stock split, an investor with 100 shares of a company would now have 200 shares, but the price of each share would be halved. If the stock was previously priced at ₹1000 per share, post-split, the share price would adjust to ₹500. Importantly, while the number of shares increases, the total value of the investment remains the same, unless influenced by market fluactuations.

Stock splits are typically declared when a company’s stock price becomes too high, making it unaffordable for average investors. By splitting the stock, the company makes the shares more affordable and accessible, potentially increasing market liquidity and demand.

Types of Stock Splits

Stock splits can take various forms, with the most common being:

• Forward Stock Split: This is the most typical form, where the number of shares is increased. For example, a 2-for-1 split means each shareholder gets two shares for every share they own, at half the previous price.
• Reverse Stock Split: In this case, the company reduces the number of shares outstanding. For example, in a 1-for-2 reverse stock split, shareholders exchange two shares for one share. The price of the stock increases, but the total value of the investment remains unchanged.

Why Do Companies Perform a Stock Split?

• To Make Shares More Affordable: If the price of a stock rises too high, smaller retail investors may be unable to afford it. By splitting the stock, companies can bring the price down to a more attractive level without altering the overall value.
• To Increase Liquidity: A stock split typically increases the number of shares available for trading, which can lead to greater liquidity in the market.
• To Signal Growth: Companies often implement stock splits when they are performing well. A stock split can be seen as a signal that the company is confident in its future growth prospects.
• To Enhance Investor Sentiment: Stock splits can increase the perception of the stock being affordable, which can potentially drive demand and improve investor sentiment.

Legal Provisions and Regulations Under Indian Law

In India, stock splits are governed by various provisions under the Companies Act, 2013 and the regulations issued by the Securities and Exchange Board of India (SEBI). Here are some key provisions that govern stock splits:

• Companies Act, 2013:

  • Section 61(1)(d): According to this section, a company may, by passing a resolution in a general meeting, subdivide its shares. This means that the company can split the nominal value of its shares into smaller amounts. The provision gives the company the power to alter its share capital, subject to approval from its shareholders.
  • Section 63: This section outlines the issue of bonus shares, and although it does not directly refer to stock splits, it is closely related because both actions affect the share capital of a company. In the case of a stock split, the company divides existing shares, while bonus shares involve issuing additional shares to current shareholders.

• SEBI Regulations:

  • SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR Regulations): These regulations govern the issuance and splitting of shares. SEBI requires that companies comply with these regulations before proceeding with a stock split. For example, if the company is listed, the stock split must be disclosed to the stock exchanges and to investors to ensure transparency.
  • SEBI Circular on Corporate Governance: This circular mandates that companies must disclose corporate actions such as stock splits in their financial statements and to the public. This ensures that shareholders are well-informed and can make decisions based on clear, accurate information.

• Stock Exchanges Guidelines:

  • Both the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) have specific guidelines for corporate actions, including stock splits. These exchanges require companies to provide details of the split, such as the record date (the date on which shareholders must own the stock to receive the split), the ratio (e.g., 2-for-1, 3-for-1), and any changes in the face value of the stock.

• Tax Implications: In India, stock splits do not have immediate tax implications for shareholders, as there is no capital gain at the time of the split. The cost of acquisition for the new shares will be proportionally adjusted based on the stock split ratio. However, when the shares are eventually sold, the capital gains tax will apply, and the holding period for calculating long-term or short-term capital gains will be adjusted accordingly.

Impact on Investors

• No Immediate Effect on Investment Value: Although the number of shares held by the investor increases, the total value of the investment remains the same immediately after the split. However, the split may increase liquidity, potentially affecting stock prices in the future.

• Improved Liquidity: A lower stock price post-split might attract more investors, especially retail investors, which could lead to higher trading volumes and greater market liquidity.

• Perception of Growth: Often, a stock split is seen as a sign of company growth and a positive outlook. This can boost investor confidence and lead to higher demand for the shares, which may cause an increase in the stock price over time.

• Market Sentiment: While a stock split does not change a company’s underlying financials, it can improve market sentiment by making the stock more accessible and attractive to a broader range of investors.

GenZCFO Advice

A stock split is a corporate action that companies use to divide their shares and make them more accessible to investors. While a stock split does not change the total value of an investor’s holdings, it can improve liquidity and market sentiment.

Under Indian law, stock splits are governed by provisions in the Companies Act, 2013 and SEBI regulations, and companies must comply with these legal requirements before proceeding with such actions. For investors, stock splits can signify a company’s growth and an opportunity to purchase more affordable shares, but it's important to understand the legal and financial implications. Ultimately, a stock split can serve as a valuable tool for both companies and investors, driving growth and accessibility in the financial markets. Contact us for any queries.

FAQs on Stock Split

- What is a Stock Split?

A stock split is a decision by a company to divide its existing shares into multiple shares to boost liquidity. For example, in a 2-for-1 stock split, every shareholder receives an additional share for each share they own, while the stock price is halved.

- Why Do Companies Split Their Stock?

Companies split their stock to:

• Increase liquidity by making shares more affordable for investors
• Attract retail investors who might be discouraged by a high share price
• Improve market perception by creating a more appealing price range

- How Does a Stock Split Work?

For example, if a company declares a 2-for-1 split, an investor who holds 100 shares at ₹1,000 each will now own 200 shares at ₹500 each. The total value remains the same.

- Does a Stock Split Change the Company's Value?

No, a stock split does not impact the company's market capitalization or fundamentals. It merely changes the number of shares and the share price proportionally.

- What Are the Different Types of Stock Splits?

• Forward Stock Split: Increases the number of shares while reducing the price (e.g., 2-for-1, 3-for-1).
• Reverse Stock Split: Reduces the number of shares while increasing the price (e.g., 1-for-2, 1-for-3).

- How Does a Stock Split Affect Shareholders?

A stock split does not impact the total value of a shareholder’s investment. Instead, they receive more shares at a lower price per share.

- Is a Stock Split a Good Sign?

Generally, a stock split indicates strong company performance and confidence in future growth, which can be positive for investors.

- Do Stock Splits Affect Dividends?

Yes, dividends per share may be adjusted based on the new share count, but the total dividend payout remains unchanged.

- What is a Reverse Stock Split?

A reverse stock split consolidates shares to increase the price per share, often done by struggling companies to meet exchange listing requirements.

- How Can Investors Benefit from a Stock Split?

Investors benefit from increased liquidity, lower share prices making stock more accessible, and potential future price appreciation.