In the world of investing, we come across terms that, at first glance, may seem complex. One of them is the stock split, also known as the subdivision of a security. What does it mean and how does it affect investors? We explain in this article.
A split refers to a type of financial market operation that involves dividing a security into several securities with a lower price, while keeping the total value of the investment unchanged.
Imagine a company with one (1) million participating securities outstanding, each worth $100; this means the company’s total value is $100 million. If the company decided to carry out a 2:1 stock split, it would mean that for each existing participating security, two new participating securities would be created. In other words, the number of securities would double, while the company’s total value would remain the same.
How does this affect investors?
- Number of securities: If an investor held 100 securities before the split, they will have 200 afterward.
- Price per security: The price per security will be divided in the same proportion as the split. In this case, the price per security would go from $100 to $50.
- Total investment value: It’s important to note that the total value of the investment does not change. If before the split an investor held 100 securities at $100 each, their total investment was $10,000. After the split, they will hold 200 securities at $50 each, but their total investment remains $10,000.
Why do companies carry out stock splits?
Companies may choose to carry out a split for various reasons:
- Increasing share liquidity: A split can increase the number of securities outstanding, which helps bring in more investors, increasing that security’s trading volumes. In this way, the mechanism promotes liquidity in the secondary market by generating a greater number of buy and sell transactions.
- Attracting new investors: This mechanism makes it easier for new investors to participate since it lowers the minimum amount needed to purchase a security. Continuing with the earlier example, before the split an investor needed $100 to acquire a security; after the split, the investor can access
the same security for an investment of $50.
For current investors, the effect of the split is neutral, since it maintains the amount of their initial investment and their stake within the universe of all securities, giving them greater flexibility in managing their investment.
It’s worth noting that this is an internationally standard mechanism that has been implemented by major multinationals such as Google and Apple, as well as by leading issuers in the Colombian securities market such as Grupo Nutresa, Grupo Éxito, and Ecopetrol.