What is a stock split and how does it work

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stock split

Not sure about how a stock split works? Well, you came to the right place! Here, we’ll give you some of the most relevant information about it. 

This article will help you expand your knowledge and have a viable alternative for your investments. First of all, we need to understand some basic things before getting deep into stock splits.

What is a stock?

Stocks are like pieces of a company. These little pieces represent the percentage of ownership shareholders (the people who buy the stock) have of the organization. 

Shareholders often receive dividends and the chance to participate in the company’s decision-making. Once a shareholder owns a stock of a company, they can trade it in the market.

What is the stock market?

The stock market is where stocks are traded; a market focused on financial trading. It’s similar to a regular market where you can buy fruits and vegetables. However, it isn’t a physical place and your groceries are replaced by financial instruments such as stocks, ETFs, and shares of a company.

Read also: Should you be afraid of the stock market?

Stock split

It’s time. Now that we are clear on what a stock is, let’s focus on what we’re here for. 

The meaning of a stock split is implied in its name, splitting a stock. It is when a full stock gets divided into multiple pieces to get a lower price for each one of them. This will increase the number of stocks a company has in the market; therefore, it will have more liquidity.

One of the main reasons to have a stock split is to make the stock more affordable for investors. Once a stock is divided, they will be able to afford the full share and benefit the original shareholders and the company itself with extra cash.

Stock split in action

Imagine you own a stock from a big company, let’s say King-Cola. For that share you own, King-Cola will determine X number of shares you will receive after the split. That is called the split factor and it is represented as X:1 (X to 1).

For example, the share you hypothetically own of King-Cola is worth $100. If the King-Cola Company plans a 2:1 split, this means every shareholder who owns a stock worth $100 will now have two shares worth $50 each.

Reasons to split stocks

There are several goals for a company that opts for a stock split. There are two main reasons:

  • Price perception: Most investors may see a stock with a price of hundreds of dollars as unaffordable. A stock split takes the stock price down even though its value doesn’t decrease. The lower the stock price is, the more enticing it would be for new investors.
  • Increase liquidity: As the number of stocks in the market increases, their liquidity is also increased. This is made to avoid large bid/ask spreads.

There it is! You now own 2 shares from King-Cola. As we said before, this can come in handy, especially if you’re looking to sell them. As their price is lower, there will potentially be more investors able to buy them, considering other factors about the market and the company of course. 

As you can see, it is quite simple. Now that you know about stock splits, start learning about the reverse stock splits. 

Ready to put this knowledge to good use? Before you go buy some stocks, take a look at the rest of the articles in our blog to learn more investing tips and get ready for your journey.

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