Part of the stock market game requires companies to entice investors with low stock prices. If stocks soar outside the price range of target investors, the company faces potential consequences in terms of investor interest and shareholder satisfaction.
A stock split resolves this problem by splitting stocks into equal parts. For example, a three-for-one stock split divides each share into three parts. An investor holding one share suddenly holds three, each valued at one-third of the original stock price.
Making Stock More Attractive
A stock split reduces the barrier to entry for a particular type of stock. Since each share looks less expensive, risk-averse or "small-time" investors might take the plunge even though they wouldn't before the split.
Maintaining Market Capitalization
While the stock looks less expensive, the market capitalization does not change after a stock split.
For instance, a company that issues 10 million shares valued at $50 each might invoke a two-for-one split. They now have 20 million shares, each worth $25. However, even though more shares are available, the overall value of the stock on the market remains the same.
Creating Impressive Gains
Many companies enjoy tremendous gains when they employ a stock split. For example, insurance company Aflac implemented a two-for-one split in 2001 and experienced gains of 73 percent, according to Forbes.
It's not a magic bullet, but a stock split benefits a company whose share prices exceed those of their competitors or the amount the market will bear.
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