How to use a stock split to increase liquidity
A stock split is a procedure whereby a company reduces the nominal value of its securities. At the same time, the number of shares in free float increases proportionally. This approach enables companies to attract new investors and make their securities more accessible.
Companies resort to splits to increase liquidity. One of the key advantages of this mechanism is that it affects important business indicators. Additionally, the ownership percentage remains unchanged. Large corporations usually use splits to stimulate market interest.
It is important to note that a split does not change the company’s actual value: while the number of shares increases, the price of each share decreases proportionally. For example, with a 3-to-1 ratio, one share is divided into three, and its price is reduced threefold.
The procedure is fully automated: the broker performs the recalculation without investor participation. Thus, a split makes securities more accessible and stimulates trading activity without the need for additional issuance.
Types of splits
Splits can take various forms, depending on the company’s goals and the market situation. The two most common options are:
1. Direct split. An increase in the total number of shares in circulation with a simultaneous proportional decrease in their price. Public companies resort to this mechanism after a significant increase in the price of their securities.
2. Reverse split. A reduction in the number of shares with a proportional increase in their price. For example, ten securities worth US$10 each would be combined into one security worth US$100.
A reverse split is advisable in the event of a sharp drop in share value. This allows companies to maintain their position on the stock exchange. However, investors may view this as an indication of problems within the business.
The objectives of a split
The main purpose of a split is to make shares more accessible to retail investors. A lower price per share expands the circle of potential buyers and increases the number of shareholders.
Another important objective is to stimulate liquidity. Splits increase trading volume on the stock exchange and maintain interest in the shares. Psychologically, shares appear more attractive after a split, helping to avoid the ‘overbought’ effect.
In turn, a reverse split helps companies to meet the listing requirements of stock exchanges and reduces the risk of delisting when prices fall. Additionally, splits can be used as a tool when including shares in stock indices.
Therefore, the correct use of the split mechanism is more than just a technical process of recalculating value. It is also a powerful element of a company’s financial strategy that affects its market image.
