What is a Split?
When a corporation divides its outstanding shares into a larger number of shares, it is called a (forward) split.
The purpose of a split is to improve the liquidity of a stock: the more shares in issue, the easier it is to match buyers and sellers.
A company will sometimes announce a stock split when its share price gets so high that it inhibits further investment. By dividing the stock, the company cuts the share price and makes the stock more affordable. In theory, a forward split results in a higher number of outstanding shares and a reduced market price per share. In reality, the post-split share price may be bid up or down as a result of market sentiment (whether investors buy more shares).
Reverse stock splits
When a company's stock is trading so low that investors will not touch it, the board of directors may opt to execute a reverse stock split in an attempt to pump up the stock's market price and attract the attention of investors. This consolidates the value of the company into a smaller number of shares, which increases the price per share.
Again, this kind of split does not alter an individual investor's equity in the company; it merely changes the number of outstanding shares.
With both (forward) stock splits and reverse stock splits, it is important to remain focused on the underlying performance of the stock rather than the headline price after the split. It can be difficult to adjust to this if you are used to keeping track of the stock's performance by referring to the pre-split price.
A company that wants to raise more capital will sometimes offer new shares to current shareholders. This is called a rights issue.
The company issues the rights in proportion to existing holdings. For example, in a one-for-two rights issue, shareholders will be offered the opportunity to buy one new share for every two they hold. The new shares are generally offered at a significant discount to encourage take-up.
As a shareholder, you are not required to exercise these rights, but if you waive them you risk diluting your existing holding as the total number of outstanding shares increases.
When a company makes a rights issue, as a shareholder you have three options:
- take up your rights and maintain your proportionate ownership of the company
- sell your rights in the open market
- do nothing and let the underwriter send you the value of your rights minus charges
If you are thinking about taking up your rights, TD Direct Investing offers its customers a comprehensive markets and research facility to help you make your decision.
A bonus issue (or scrip issue) is a stock split in which a company issues new shares without charge in order to bring its issued capital (outstanding stock) in line with its employed capital (the increased capital available to the company after including retained profits). This usually happens after a company has retained profits, thus increasing its employed capital. Therefore, a bonus issue can be seen as an alternative to dividends. No new funds are raised with a bonus issue.
Free float (or free capital) is the portion of a company's equity that is available for trading on the stock market.
Free float can be important in that it affects the liquidity of your stock. If a company only has a small proportion of its stock available in the market, it becomes more difficult to match buyers and sellers. The risk with illiquid stock is that you may not be able to buy or sell immediately and at your chosen price. Also, a scarcity of shares usually pushes the share price upwards.
Free float is particularly relevant to initial public offerings (IPOs) where a small proportion of stock is released to the public, often in the face of huge demand. The effect on the post-flotation share price can be dramatic and investors should beware of buying at too high a price.